NPS vs Mutual Fund

NPS vs Mutual Fund

The main difference between NPS or National Pension Scheme and a Mutual fund is that NPS aims to save funds of an employee (both government and private sector) and offer them investment benefits after retirement whereas a mutual fund is an investment scheme where investors put their money to receive higher returns on their investments.

This article covers: 

What is NPS?

NPS, also known as the National Pension System is a voluntary government-sponsored pension scheme launched in 2004. The scheme aims to provide retirement benefits to individuals by allowing them to invest in a diversified portfolio of assets such as equities, corporate bonds, and government securities. 

NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA) and has become a popular investment option due to its low fees and tax benefits. Under NPS, subscribers can choose to invest in two types of accounts – Tier-I and Tier-II. Tier-I is a mandatory account that comes with a lock-in period until the subscriber reaches the age of 60, while Tier-II is a voluntary account that can be withdrawn at any time without any penalty.

For example, let’s say, Mr. Sharma, a 30-year-old working professional, wants to invest for his retirement. He decides to open a Tier-I NPS account and invests Rs. 50,000 per year. Assuming an average annual return of 8%, he would accumulate a corpus of around Rs. 36.9 lakhs by the time he reaches the age of 60.

What is Mutual Fund? 

A mutual fund is a type of investment vehicle that pools money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. The fund is managed by a professional fund manager who uses the pooled money to buy and sell securities based on the investment objective of the fund.

Mutual funds are regulated by the Securities and Exchange Board of India (SEBI) and come in various types such as equity funds, debt funds, balanced funds, and index funds. Each type of fund has a different investment objective and risk profile, catering to the diverse investment needs of investors.

For example, let’s say, Ms. Patel, a 35-year-old investor, wants to invest in the stock market but does not have the expertise to pick individual stocks. She decides to invest in an equity mutual fund that has a proven track record of generating good returns. She invests Rs. 10,000 per month in the fund and holds the investment for 10 years. Assuming an average annual return of 12%, she would accumulate a corpus of around Rs. 24.4 lakhs at the end of 10 years.

Difference Between NPS and Mutual Fund

The major differences betwneen NPS and mutual fund lies in terms of tax benefits. NPS can offer investors a tax deduction of up to Rs. 2 lakhs whereas in mutual fund category, only ELSS funds offer tax benefits. 

1. NPS vs Mutual Fund – Level of Potential Risk

NPS invests in equities, corporate bonds, and government securities based on subscriber preferences. The risk exposure of the investment depends on the asset allocation of the subscriber. For example, if the subscriber chooses a high allocation to equities, the investment will have a higher risk exposure. However, if the subscriber chooses a high allocation to debt instruments, the investment will have a lower risk exposure.

On the other hand, mutual funds come in different categories based on their investment objective and risk profile. Equity funds have a higher risk exposure as they invest predominantly in stocks, while debt funds have lower risk exposure as they invest in fixed-income securities. There are also hybrid funds that invest in a mix of equities and debt instruments, providing a balanced risk exposure.

2. NPS vs Mutual Fund – Tax Benefits 

NPS provides tax advantages in accordance with Sections 80C and 80CCD of the Income Tax Act. Employer contributions are tax deductible up to 10% of basic salary and dearness allowance, while contributions made to the Tier-I account are tax deductible up to Rs. 1.5 lakh per year. In addition, for contributions made to the Tier-I account, subscribers are eligible for tax deductions under Section 80CCD(1B) of up to Rs. 50,000.

Mutual funds also offer tax benefits, but they are subject to capital gains tax. Long-term capital gains (holding period of more than 1 year) on equity mutual funds are taxed at 10% without indexation, while short-term capital gains (holding period of less than 1 year) are taxed at 15%. Debt mutual funds are taxed based on the holding period and the investor’s tax slab.

3. NPS vs Mutual Fund – Allocation of Equity

NPS invests in a mix of equities, corporate bonds, and government securities based on the subscriber’s preference. The equity exposure of the investment depends on the subscriber’s asset allocation. NPS offers three different asset allocation options to subscribers – aggressive, moderate, and conservative. The aggressive option has the highest equity exposure, while the conservative option has the lowest equity exposure.

Mutual funds invest predominantly in either equities or debt, depending on the investment objective of the fund. Equity mutual funds invest predominantly in stocks and provide exposure to the equity market. Debt mutual funds invest predominantly in fixed-income securities and provide exposure to the debt market. There are also hybrid funds that invest in a mix of equities and debt instruments, providing a balanced exposure.

4. NPS vs Mutual Fund – Withdrawal Adaptability 

NPS has a lock-in period until age 60, with 60% withdrawable and 40% used to purchase an annuity. Partial withdrawals are allowed after 3 years under certain conditions. In contrast, mutual funds offer more flexibility, allowing partial or full withdrawals anytime, subject to exit loads and taxes. Exit loads apply if investments are redeemed before a specified period, typically one year.

5. NPS vs Mutual Fund – Yield on Investment

NPS has seen an average return of 8-10% over the past decade, depending on asset allocation, with returns being market-linked. It has a low expense ratio of 0.01%, making it a cost-effective option. Mutual funds’ returns vary based on fund category and market conditions; equity funds have averaged 12-15% returns, while debt funds have seen 6-8% returns over the past 10 years.

6. NPS vs Mutual Fund – Liquidity Period 

NPS has a mandatory lock-in period until age 60, with partial withdrawals permitted after 3 years under certain conditions. Premature withdrawals are only allowed in specific cases. Mutual funds provide higher liquidity, as investors can redeem investments at any time, subject to exit loads and taxes, with a faster redemption process compared to NPS, which takes 3-5 business days for withdrawal.

7. NPS vs Mutual Fund – Management Fees

NPS has a low expense ratio of 0.01%, making it a cost-effective investment option in India, with fees deducted from returns rather than charged separately. Mutual funds, on the other hand, charge fund management fees as a percentage of assets under management. Expense ratios for mutual funds depend on the fund category and house, with equity funds typically having higher ratios due to increased management costs associated with equity investments.

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NPS vs Mutual Fund- Quick Summary

  • NPS is a government-backed retirement savings scheme, while Mutual Fund is a professionally managed investment fund.
  • The primary aim of NPS is to offer retirement benefits to both government sector and private sector employees and individuals can reap investment benefits by paying an extremely low amount of fees. 
  • In mutual funds, an investment corpus is accumulated from multiple sources (investors) and they are used by an AMC to invest in the stock market and generate a significant amount of return for the investors.
  • The primary distinction between the two is their risk exposure, returns, and tax advantages. NPS is a safer investment with greater tax advantages, whereas mutual fund returns are superior. 
  • NPS has restrictions on withdrawals, while Mutual Fund offers greater flexibility in this regard.
  • Return on investment in NPS is relatively stable, while Mutual Fund has the potential for higher returns but with higher risk.

NPS vs Mutual Fund- Frequently Asked Questions

1. What is the Difference Between NPS and Mutual Fund?  

NPS is a retirement-focused investment scheme managed by the government, while mutual funds are investment schemes managed by private companies for various financial goals.

2. Which is Better: NPS or Mutual Funds?

Both NPS and mutual funds have their own advantages and disadvantages. The choice depends on an investor’s financial goals, risk appetite, and investment horizon.

3. What are the Disadvantages of NPS?

One of the main disadvantages of NPS is its mandatory lock-in period until the subscriber reaches the age of 60. This means that investors cannot withdraw their funds before the age of 60, except in specific cases such as critical illness or death.

4. Which is Better than NPS?

PPF or Public Provident Fund is considered a better investment vehicle than NPS because it offers higher returns as well as flexibility, and can be used to fulfill multiple objectives. However, the choice of investment option depends on the investor’s investment goals, risk appetite, and investment horizon. 

5. What is the Advantage of NPS over Mutual Funds?

The advantage of NPS over mutual funds is its tax benefits. NPS offers tax benefits under Section 80C and Section 80CCD(1B) of the Income Tax Act, which allows investors to claim deductions up to Rs. 2 lakhs on their taxable income.

6. Is NPS Good for the Long Term?

Yes, NPS is a good investment option for the long-term, as it is designed to provide retirement benefits to subscribers. The mandatory lock-in period until the subscriber reaches the age of 60 ensures that the funds are invested for the long term.

7. Is NPS Tier 2 better than Mutual Funds?

NPS Tier 2 and mutual funds are different investment products. While NPS Tier 2 has certain benefits, mutual funds can provide higher returns and greater flexibility for investors.

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