One is a guaranteed return product and another is market-linked. Even well-educated people who attend Moneylife Foundation seminars don’t understand the distinction between the two
Employees may soon have an option to choose between the employee provident fund (EPF) scheme run by retirement fund body EPFO and National Pension System (NPS). A proposal in this regard is expected to be discussed by the Cabinet next week. The proposal is part of the bill to make comprehensive amendments to the Employees' Provident Funds and Miscellaneous Provisions Act 1952.
We all love choice but exercising choice in which colour of shirt or dress to choose is different from making choices in financial products. Choices are at the heart of many bad decisions because people either adopt the default choices or choose at random. Jason Zweig, author of the classical book ‘Your Money and Your Brain’, reports the study of hundreds of 401(k) plans (defined contribution plans for retirement in the US) which found that the more funds a plan offers, the more reluctant people are to sign up and save for their retirement. “The harder the choice feels, the less people want to choose,” explains Zweig. Adding even more choices will lower one’s odds of making a good decision and increase their chances of regretting whatever decision they make.
While in the current scenario, the employee will have to choose between EPF or NPS, though it may seem fairly simple, the employee will know little of the pros and cons of investing in each. The government may end up creating confusion among workers and employees by offering them a choice. EPF is a guaranteed scheme run by the government. NPS will invest in market-linked products. They are as different as chalk and cheese. We have noticed that even the urban, educated people who have attended dozens of financial literacy seminars of Moneylife Foundation, do not know the difference between fixed income products, where capital is guaranteed and so-called fixed income products that are market-linked and therefore, volatile.
Another study published in Nudge, a book written by University of Chicago economist Richard H. Thaler and Harvard Law School Professor Cass R. Sunstein, found that when investors were provided two investment choices, one of stocks and the other of bonds, they invested 50% in each. The experiment was repeated, but this time the participants were provided the choice of stocks and a balanced fund (50:50, stocks and bonds). Here again, they invested 50% in each. Going by the first allocation, they should have ideally chosen the balanced fund, but they chose to split the investment evenly between the two options, increasing their allocation to stocks. This shows that the average person finds it difficult to weigh even the simplest of investment choices.
“Most employees have difficulty understanding how numbers like savings rate, expected rate of return, and volatility translate into changes in lifestyle when they are old. Most people would need some help,” the authors write.
The Employees' Provident Fund Organisation will be the regulatory body for monitoring the implementation of the scheme as there could be cases, where worker neither go to EPF nor NPS. This is in line with finance minister Arun Jaitley’s Budget 2015 speech.
“With respect to the EPF, the employee needs to be provided two options. Firstly, the employee may opt for EPF or the New Pension Scheme (NPS)...For employees below a certain threshold of monthly income, contribution to EPF should be optional, without affecting or reducing the employer's contribution," Jaitley had said in Parliament.
Whether the government will provide a default option is still not known.