For years, defined benefit schemes ruled in India. Your first investment is most likely a post office scheme that guarantees a 7 per cent or above return. According to the Reserve Bank of India data, post office small savings schemes’ outstanding balance stands well over Rs 15,00,000 crore. The government guarantee means it owes an interest rate to you each year on these savings. Such savings are a burden on the country’s budget.
A quiet revolution has taken place over the past decade or so. The National Pension Scheme (NPS) will soon touch Rs 10,00,000 crore in assets under management, according to Deepak Mohanty, chairman of the Pension Fund Regulatory and Development Authority of India or PFRDA. NPS is a defined contribution scheme. There is no government guarantee on the money you contribute each month. Returns are market-linked, and you can determine the equity component in your portfolio. It was open to government employees earlier and extended to non-government workers too.
As this column has argued in the past, NPS can do what 401 (k) contributions did to American households. They created a savings revolution and did not burden the government finances. The government’s guarantee would have cost much higher had NPS not been launched in 2010. It is much easier now to sign up for an NPS than before. It can be done on your smartphone too. For salaried people, NPS is the most important investment you will ever make.
Starting early
The government is encouraging those entering the workforce to open a NPS account. A lot of awareness is created as you can use your saving account internet banking to sign up. All banks are pushing the initiative and gathering accounts for the government. It achieves the objective of reducing the burden on the exchequer as the government does not have to guarantee returns. At the same time, it offers market-linked returns to you that are much higher than the prevailing guaranteed return schemes or inflation over the long term. NPS is primarily a long-term savings product, and your pension fund can swell into a sufficient amount for you to retire in peace.
There is a need to push for appreciating the NPS early. The government must reach out to high school students and push the importance of savings and investment in the curriculum. There is no education on personal finance in school or college curricula.
Personal finance is a complex topic for adults to appreciate. Putting too much information about investing and saving could put off the young. There is a need to explain savings products that offer a guaranteed return and a defined contribution product like NPS that offers market-linked returns. Since retirement is a long-term financial goal, the government should take sides and push for NPS and avoid promoting guaranteed return products. Over the long term, it is empirically proven that equity assets generate a higher return over 15-20 years.
An allocation to an index fund can help you beat inflation and create adequate retirement savings. In 1980, the S&P BSE Sensex was at 100. By 2000, it surged to 3000; by 2020, it was at 48000. As the economy grows, businesses sell goods and services and generate steady profit growth. It is safe to assume that the Sensex could give similar returns over the next 20 years.
As India’s economy grows faster and inflation eases, you can create wealth for your golden years through a disciplined savings approach. The government-guaranteed returns tend to offer you a return along the lines of the 10-year government bond yield. Currently, it is hovering around 7 per cent. A guaranteed return of around 7 per cent can only take care of inflation. It cannot create wealth for a comfortable retirement.
The other advantage of starting early with the NPS is that you can contribute small amounts and create a meaningful pool of money. You will allow your hard-earning savings the time to grow and multiply. Despite a loud noise about equity investing directly or through mutual funds, only 3 per cent to 4 per cent of people voluntarily own equity assets. NPS is the right nudge to trigger an equity cult in India.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)