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NPS or Equity Mutual Fund – What is a Better Retirement Tool?

Written by - Akshatha Sajumon

January 22, 2022 6 minutes

Retirement is something most individuals plan for from very early ages. One of the most important aspects that needs to be kept in mind while planning the same is to invest in avenues that offer inflation-beating returns. 

If that were to be one’s main consideration, then there are multiple options available – ranging from Employees’ Provident Fund to National Pension Scheme to Mutual Fund Systematic Investment Plans to debt instruments. 

But there are two important options available that receive higher consideration by most investors and that is NPS and Equity Mutual Funds. Wish to know more about these? Read on!

What Is the National Pension Scheme?

National Pension Scheme or NPS is a government retirement scheme meant to develop a sizable corpus for retirement. Originally meant for only government employees, this scheme allows for investment by non-public sector employees too. 

The main advantage of investing in these funds are –

  1. There is flexibility in investment. One can increase or decrease his or her contribution on an annual basis.
  2. The equity exposure is limited for these schemes and hence, they come with lower risk. But this also means that the returns are sizeably lesser. 50%-75 % of the investments made in NPS are exposed to equity depending on your risk profile.

What is an Equity Mutual Fund?

Based on the allocation of assets to a specific fund, mutual funds are categorized as equity mutual funds, debt mutual funds and hybrid mutual funds. 

Equity mutual fund, in specific, refers to those funds where more than 70% of the assets are invested in equity stocks of companies.

These are further classified as –

  • large cap funds (at least 80% investments are in companies that have a large market capitalisation)
  • mid cap funds (at least 65% investment in mid cap companies)
  • small cap funds (at least 65% investment in small cap companies)
  • multi cap funds
  •  (which invests a minimum of 65% in equity and equity related instruments)
  • ELSS (at least 80% of the total assets is invested in equity and equity related instruments for a lock-in period of 3 years)

These funds can be invested either through the lump sum mode or the SIP mode – the latter is to be paid at fixed intervals.

The power of compounding is what makes mutual funds a very lucrative option for investors and the high returns delivered helps beat inflation efficiently. 

What are the similarities Between Equity Funds and NPS?

  • Structurally, both are the same as the pool in money from the investors and channelize the same into different asset classes.
  • Both are professionally managed.
  • Both are eligible for tax deductions under Section 80C.
  • Contributions made into the corpus are voluntary.
  • There is flexibility in the withdrawal of the funds.

Differences Between Investing in Equity Mutual Funds and NPS

BasisNPSEquity Mutual Fund
Meaning It is a government retirement scheme meant to develop a sizable corpus for retirement.It is a financial instrument managed by professionals that generate returns over a long period of time by investing in to equity.
Equity exposureThe equity exposure is merely 50-75%.The equity exposure can go up to 100%.
Historical performance of returnsDelivered approximately 8-10% returns on average annually.Delivered 14-18% in the long term.
Risk Low risk as it is government-backed.The risk depends on market fluctuations. 
Fund managerCan change fund manager every financial year.No such option exists once invested in a fund.
Asset classInvestors allocate funds into 4 asset classes namely, Equity, Corporate Debt, Government Bonds and Annuity.Investors allocate into equity predominantly.
Lock in periodUsually till retirement. No such lock in period for most equity funds. These funds are highly liquid.
Types There are two kinds of NPS accounts – Tier I and Tier II.There are many types of equity funds – large cap funds, mid cap funds, small cap funds, multi cap funds and ELSS funds.
Minimum contribution Minimum is Rs. 1000. There is no maximum.Minimum is Rs. 500. There is no maximum. 
Tax benefitThe entire amount is tax free i.e. EEE.The entire amount is subject to either short term or long term capital gains tax. If it is for short term then it will be 15% and if it is for long term, then the tax rate will stand at 10%.
Costs of the fundLowest cost managed fund.The cost incurred is variable.

NPS or Equity Mutual Funds – The Better of The Two?

  • While both instil a sense of financial discipline in one’s life, equity mutual funds offer certain additional benefits that NPS does not. For instance, mutual funds act as emergency funds by virtue of the flexibility it has to offer, the returns it can give, the SIP option and scope for modifications and changes.
  • If one starts investing in equity mutual funds from a younger age and stays invested for a longer period of time, then one would be able to amass a decent corpus through the power of compounding.
  • Investing in Equity Funds also enables the investor to benefit out of the rupee cost averaging – a cushion against market volatility.
  • Having said that, an individual with a lower risk appetite and someone who wishes to save a greater amount on taxes must go in for NPS as it offers both these advantages. 
  • One can even consider investing in both the instruments. NPS can ensure the stability and security that the investor yearns for, while Equity mutual funds can help the investor reap the rewards of capital growth. The ratio with which the investment is made can also be varied. 
  • Ultimately, while choosing either of the two options, it is important that the investor weighs all the pros and cons and makes a conscious decision about which investment option fulfils his or her investment goal the best.
  • One must consider the probable age of retirement, the amount of corpus that needs to be accumulated, the investment horizon and the risk profile before taking this decision. 

Frequently Asked Questions

  1. What are the risks involved in ELSS?
    There are three main kinds of risks involved in ELSS mutual funds. They are – market risks, volatility risk, and concentration risks.
  1. What is the difference in lock-in periods of ELSS and NPS?
    ELSS has a lock-in period of 3 years, whereas, NPS is locked-in till the retirement of the individual.
  1. How does one pick a good ELSS?
    In order to know if an ELSS is performing well and is worth the investment, the investor is to look at the past returns, expense ratio, other financial ratios, consistency in returns, effect of market turbulence etc.
  1. In all of the investments to reduce one’s tax liability, is ELSS worth the investment?
    Amongst all those funds and investments covered under Section 80C, ELSS has the best bet at offering the highest returns. However, one has to keep in mind that tax deductions can only be availed for amounts lower than Rs. 1.5 lakhs.
  1. Can the returns be availed as and when for ELSS or NPS?
    ELSS offers market-linked investment on redemption of units after a 3 year period. However, in case of NPS, a lump sum amount inclusive of interest and principal on maturity will be returned.

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