The National Pension Scheme offers investors options in the kind of investment fund they would like to invest, based on their risk appetite. Among the options are equity based investments, where up to 50 % and up to 75 % of the invested amount is invested in equities or shares. The primary objective of choosing the equity option is the hope that more money will be earned. This is fine as long as the share market is going up. Share and debt markets are volatile. If they go up, they also go down. What happens when the share market falls, as it is currently happening? The pensioner’s hard earned income suddenly gives lower return. The pensioner earns less money and a lower pension. Continue reading after the two colored boxes below

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There are two types of pension plans that one can invest in. One is called the defined benefit scheme and the other defined contribution scheme.

Defined Benefit Schemes

In a defined benefit scheme, the investor can seek to earn a guaranteed amount every month, such as Rs.10,000 or Rs. 20,000 per month. Depending on the amount defined by the investor, the premium or the corpus for investment is determined. For example to earn a pension of Rs. 15,000 per month, the defined corpus for investment may be Rs. 25,00,000. If the defined benefit is more than or less than Rs. 15,000 per month, accordingly more or less corpus is to be invested in the annuity.

Defined Contribution Schemes

In the defined contribution scheme, the investor decides how much to invest in the annuity and the monthly pay out as pension gets determined by the market performance of the fund in which the investment is made. Just as in ULIPs, the NAV is calculated and a payout is made monthly based on the fund performance.

Market Performance of Defined Contribution Schemes

Financial Express reported (using the NPS Trust as the source) on 26 March 2020, the following returns on some of the funds of National Pension Scheme (NPS).

Negative 1 year Returns Impacts Long term returns

From the Table above it can be observed that all the reported funds are showing a one-year negative rate of return. Even the long term returns are in the region of 7 % to 8 %, which incidentally compares with low risk investment options such as life insurance and banks. Before the share market crash began, the long term returns looked very good. But after just a few weeks of a bad market performance, the long term returns do not look much better than low risk investments. Any further drop that is significant will make the NPS funds unattractive as compared to low risk investments. Experts are expecting the markets to keep falling at least for a few months more.

Corona Virus has severely impacted the share markets

The recent fall in the prices in the share market is due to the corona virus attack. The fall in share prices is to be expected. If not corona there will be some other reason. There is nothing one can do about it. The share market is susceptible to various risks. The Corona virus is one of them, especially since the virus has led to national shut down resulting in business losses. These are risks that are inherent in the share markets.

But what about an OLD MAN’s pension? Should it be exposed to the risk of a reduced pension?

But the question is about an old man’s pension. Should his or her pension be susceptible to market volatility? Is defined contribution the way forward? LIC, for example, offers a guaranteed pension (defined benefit). The state of the market does not affect the pension pay out every month. Markets may go up or go down. The guaranteed pension is paid month after month.

Financial Planners mislead investors

For a pensioner, which is more suitable? The question has an obvious answer, which all prudent thinkers with common sense know. But financial planners confuse the whole matter by suggesting that if a pensioner wants to earn more for the same amount invested he or she should go in for variable pension, which varies in accordance with market prices of shares and other securities. For some reason there is a deep rooted belief that you earn more in market instruments such as shares and debentures, as compared to life insurance or banks.

Investing in financial markets does not necessarily get you higher returns, it only gets you higher risks

In this blog we have shown time and again in the past, this is not so. It is not so when the markets are up and it is not so when the markets are down. It is not so because in the long run, volatility of market prices kills profit and in the end the investor will be lucky to earn more than the bank rate of interest or the rate of annuity in a defined benefit life insurance pension plan.

An example

Now consider that the current NAV of a top performing fund of NPS was Rs. 30 a few weeks ago and after the share market crash it fell to Rs. 20. Assuming that the corona related risk will remain for about one year, (as most market experts are predicting) when will the pension come back to an NAV of Rs. 30? After another 2 years? In the meanwhile the pensioner will have to settle for a lower pension. Since experts also feel that corona will result in high inflation in the months to come, the pensioner will have to struggle financially.

Another perspective

Let us look at it another way. Suppose a would-be pensioner entered the fund when the NAV was Rs. 30, and now the NAV is Rs. 20. The pensioner will be receiving approximately 2/3 of the pension that he or she had expected in the first place. This is very similar to Ponzi schemes. You put money in the Ponzi scheme expecting to get a double or triple return in a few months and you end up losing all your money. Only in the case of NPS, the loss is not complete, and the scheme is being run under the supervision of a government authority. But to the investor, the result is more or less the same – loss of pension for no fault of his or hers – except that they were tricked to take risks on false hopes of earning more money.

Sell only defined benefit schemes for pension

It was unfair to lead the pensioner to believe that he or she will earn more through NPS by choosing a fund that invests more in equities, especially without explaining the downside risks. It is also ethically wrong to lead the customer to believe this. When we sell on the basis of risks we sell defined benefit schemes for the purposes of pension. Which is the reason we should ……

Sell Risks Not Returns
Because Returns Are Uncertain, While Risks are Certain

Look out for articles in the immediate future on ULIPs and how to sell them. Follow ethically correct practices to earn your customer’s trust and confidence and to establish yourself as a successful agent.

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