NPS Vatsalya vs mutual funds: The NPS Vatsalya scheme was floated earlier this week, which is one-of-a-kind scheme where parents can start saving for their minor children much before they enter into their adult life. The NPS Vatsalya is a long-term pension scheme proposed during the full Union Budget 2024, following the third-term victory of the NDA government.
The NPS Vatsalya scheme enables parents to invest in the name of their children until they reach 18 years of age. Upon reaching 18 years, the account seamlessly transitions into a regular NPS account. The primary goal is to amass a substantial corpus for the children over an extended period.
Parents or guardians have the option to make a minimum annual contribution of Rs 1,000 towards the NPS Vatsalya, with no specified maximum limit on investments. This initiative seeks to encourage parents to begin saving for their children’s future by utilizing a pension account and taking advantage of the benefits of compounding for long-term financial growth. The NPS Vatsalya offers flexible contribution and investment options to cater to individual needs and preferences.
Experts have lauded the concept of long-term investment and the power of compounding. However, many lock-in period in schemes such as this can be a deterrant as investors may want to have greater liquidity and control over your investments. Also, they may want to have easy redemption policies.
“When it comes to choosing the right investment, long-term diversified equity funds are usually the best bet for investors. They don’t have a lock-in period, so you have liquidity and control over your investments. On the other hand, options like NPS Vatsalya lock your money in until your child turns 18, and even then, you can only withdraw 20%, with the rest going into annuities. Plus, you’re required to allocate 25% to debt products, so you don’t have much say in how your money is invested. Similarly, solution-oriented children’s mutual funds lock your money in for five years or until your child turns 18. While they do offer a mix of equity and debt, you still don’t get control over the asset allocation. That’s why long-term diversified equity funds stand out—they give you control, flexibility, and liquidity,” said Chirag Muni, Executive Director, Anand Rathi Wealth Limited.
He added: “It’s also smart to invest across different market caps and fund categories, like value, contra, and flexi-cap funds. This kind of diversification helps spread out risk, outperform the market, and boost your returns over the long term.”
What are the advantages of NPS Vatsalya?
The compounding effect within NPS Vatsalya plays a crucial role in turning modest, regular investments into a substantial wealth reserve as children transition into adulthood and achieve financial independence. This process also fosters a culture of financial responsibility and frugality among both children and their guardians.
Furthermore, the performance of NPS funds has been outstanding since its inception (2009 for private sector NPS), with equity strategies yielding a return of 14%, corporate debt options at 9.1%, and government securities (G-sec) providing an impressive 8.8% return on investment.
Puneet Gupta, Tax Partner, EY India, said: “The NPS Vatsalya Scheme has been implemented as a savings-cum-pension scheme which enables parents to invest in an NPS account on behalf of their minor children. One of the key features is that the account can be transitioned to a regular NPS Tier-I account of the child once he / she attains the age of 18. This may help promote the NPS Scheme for the youth and encourage them to continue with the NPS in future. It may also serve as a mechanism for parents / guardians to secure their children’s future through regular contributions to the minor’s NPS account.”
“By starting early, parents can leverage the power of compounding to ensure substantial growth over time. NPS Vatsalya is designed to make long-term financial planning accessible to all families. Parents or guardians can start investing for their child’s future with contributions as low as Rs 1,000 annually,” said Rajesh Khandagale, Head – National Pension System, KFin Technologies.
Long-term diversified equity funds as a choice
A diversified equity fund is an investment vehicle that invests in companies across different sizes and industries with the goal of maximizing returns for investors. This strategy involves spreading investments across the stock market to increase potential profitability. These funds are commonly found in unit-linked insurance plans (ULIPs), mutual funds, and various financial institutions. Stock exchange-listed companies are typically classified based on their market capitalization. Large companies, or large caps, have significant market capitalizations. Mid-sized companies, or mid caps, have medium market capitalizations. Smaller companies, or small caps, have smaller market capitalizations.
Investing in mutual funds offers the key benefit of liquidity, allowing investors to easily buy and sell their investments as needed, providing flexibility and convenience. This feature can be particularly advantageous in times of urgent financial requirements.
In general, most mutual funds, especially open-ended ones, do not have a lock-in period, permitting investors to access their funds whenever necessary. However, certain exceptions exist, such as Equity-linked Savings Schemes (ELSS) which have a lock-in period of three years, and solution-oriented plans like Children’s Fund and Retirement Fund which have a lock-in period of five years.
On the other hand, close-ended funds may have lock-in periods ranging from 3 to 5 years. This characteristic provides fund managers with more freedom to select investments with lower liquidity, as they are not as concerned about investor redemptions during this period.
“The conditions for partial withdrawal and complete exit make the product restrictive compared to, say, a mutual fund, where you can withdraw whatever amount you like at any point. The equity schemes available here are likely to be tilted towards large-cap companies. “The inability to build a portfolio tilted towards mid- and small-cap companies, which can offer attractive returns over the long term, is another shortcoming of this scheme,” said Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
“NPS Vatsalya is tailored for retirement planning with a minimum investment of Rs 1,000 annually and equity exposure capped at 75%. This option is low to moderate risk. Long-term equity funds focus on wealth creation, offering up to 100% equity exposure with flexible withdrawals. Starting from Rs 500, they are ideal for high-risk investors seeking long-term growth, though gains over Rs 1.25 lakhs are taxed. Children mutual funds are designed for future child-related expenses, with 65-100% equity allocation and a starting investment of Rs 100. Overall, NPS (Vatsalya) is best for conservative, long-term retirement planning, long-term equity funds suit investors looking for higher returns with higher risk, and Children mutual funds offer a balanced approach for future-focused financial planning,” said Swapnil Aggarwal, Director, VSRK Capital.
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