If I invest in large cap, small cap, and flexi cap mutual funds vs similar equity allocation in the National Pension System (NPS), which option is likely to deliver better long-term returns? How do they compare in terms of flexibility and performance?
Advice by Rajani Tandale, Senior Vice President, Mutual Fund at 1 Finance
When it comes to long-term equity investing, two of the most popular choices for Indian investors are mutual funds and the National Pension System (NPS). While mutual funds offer flexibility, liquidity, and access across market caps, NPS brings structure, discipline, and tax efficiency—especially for retirement-focused goals. The choice isn’t just about returns, but also about investor behaviour, risk tolerance, and long-term commitment. Here’s how the two stack up—and why a mix of both might be the smartest move.
When comparing investments in large-cap, small-cap, and flexi-cap mutual funds versus similar equity allocations within the National Pension System (NPS), several factors come into play, including historical performance, flexibility, tax implications, and investor behaviour.
Mutual funds are unstructured, flexible tools that can be used for various goals like wealth creation, home buying, education, etc.
NPS is a dedicated retirement tool, ideal for those who may otherwise underinvest for retirement. It comes with automatic glide paths (in Auto Choice) that reduce equity exposure as one ages.
Mutual Funds vs NPS
When comparing mutual funds with the equity allocation in the National Pension System (NPS), it’s important to understand both the investment structure and investor behaviour over the long term.
Mutual funds offer investors a wide range of choices across market capitalizations, large-cap funds invest in stable, blue-chip companies; mid-cap funds target growth-oriented medium-sized firms; and small-cap funds aim at emerging companies with high growth potential but also higher volatility. Flexi-cap funds provide flexibility to the fund manager to allocate dynamically across market caps based on market conditions.
On the other hand, NPS allows equity exposure up to 75% under the Active Choice option, primarily through index-based large-cap and select mid-cap stocks. While NPS equity options may underperform small-cap mutual funds in bull markets, they provide a more stable, passive exposure with lower volatility and cost.
Behavioural aspects play a crucial role in actual investor returns. Small-cap funds may show stellar past performance, especially over 10+ years, but they also experience the highest drawdowns (30% to 50% losses during market volatility). During market downturns, many investors panic and exit, locking in losses. Mutual fund investments are liquid, but that very liquidity leads to impulsive decisions.
In contrast, NPS has a lock-in until retirement (age 60), which discourages knee-jerk exits and enforces long-term discipline – ironically turning the lock-in into an advantage, not a drawback. Its structure compels investors to stay invested through market cycles, harnessing the power of compounding.
While mutual funds offer flexibility, the NPS scores high on stability, discipline, and tax efficiency, while also delivering returns comparable to mutual funds. One of the major benefits of NPS is that it provides a structured retirement solution, an area where many individuals fall short in planning. A blended approach, investing in both mutual funds and NPS can help investors strike the right balance between growth and consistency over the long term.
What way should investors go
There is no one-size-fits-all answer. Here’s a practical approach:
If You Want… Choose…
High flexibility & customisation Mutual Funds
Retirement-focused, disciplined growth NPS
Tax-efficient long-term savings NPS + ELSS Funds
Market-linked growth + liquidity Mutual Funds
Best Strategy: Combine both.
Use mutual funds for growth and diversification, and NPS for disciplined, tax-efficient retirement savings. This hybrid approach helps balance returns, risk, and retirement security.