It's time for a reality check for government employees who believed their NPS investments will outperform the traditional Provident Fund. Despite a 15% of equities, the NPS funds for government employees have given a return of 8.78% in the past five years, compared with the 8.62% return delivered by the Provident Fund during the same period.

Recent reports have suggested that NPS funds have given good returns. But those calculations were based on point-to-point NAV returns and did not truly capture the returns of monthly investments. This is why our calculation is based on the monthly contributions starting April 2008 till March 2013 to the NPS fund managed by the UTI Retirement Solutions. Put simply, these are the SIP returns of the fund for the past five years.

Pension Fund Regulatory & Development Authority (PFRDA) chairman Yogesh Agarwal is not surprised by these numbers. There can't be a big difference because the government allows only 15% of the corpus to be invested in stocks. The PFRDA wants the government employees to be allowed the same investment choices in the NPS as other investors. A private sector investor in the NPS can choose his asset allocation. Bullish investors can put up to 50% of their corpus in equity funds while risk-averse can allocate their entire portfolio to debt funds.

But a higher equity exposure may not have helped boost returns. In the past four years, the equity funds of the NPS for the general public have lagged debt funds. The calculation is based on the NAVs of the first reporting day of every month since June 2009. Aggressive investors, who allocated the maximum 50% to equity, have earned an average 7.3%, while balanced investors earned 8.3%.

However, the biggest surprise was the return earned by ultra-cautious investors, who steadfastly stayed away from the stock market. They have earned an average 9.74%.

Should you invest in equity?

For investors the big question is: should they expose their retirement savings to a volatile asset class such as stocks? Central PF Commissioner It is possible to earn good returns without compromising on safety. The EPFO has recently liberalised the investment norms for the Provident Fund, which could help the EPF earn 50-75 basis points higher returns.

However, market experts scoff at this ultra-cautious approach. Their contention: a 100% debt portfolio will never beat inflation. Financial planners too insist that you can't ignore equity when investing for retirement. You need to have some portion in equity, otherwise you might miss your pension target.

How much is enough?

The problem lies in defining the 'portion' as a percentage of retirement savings. Every individual has a different risk profile and various investment options offer different levels of equity allocation. The NPS funds for government employees put 15% in stocks and private NPS investors can invest up to 50% in this volatile class. If you have a unit-linked pension plan from a life insurance company, you can put up to 90% of your investments in equity.

There's also a rule of thumb that says one should have an equity exposure of 100 minus one's age. So, at 30, you should have about 70% of your portfolio in equity. At 55, the exposure to this volatile asset class should have been pared down to 45%. In fact, the NPS offers an auto choice where the investor's age decides the equity exposure. The 50% allocation to equity reduces every year by 2% after the investor turns 35, till it becomes 10% at the age of retirement.

So, how much should you allocate to equity when saving for retirement? The portfolios of some of the top performing MIP mutual funds provide some answers. These schemes have 15-25% of their corpus invested in stocks. The equity exposure of the Birla Sun Life MIP II Savings 5 is capped at 10% and has averaged 6.8% in the past five years. Yet, its SIP returns since April 2008 are marginally lower than those of the other top performing MIPs. So, higher returns don't necessarily require higher risks.

Retirement is a non-negotiable goal. The worst thing you can do is to be lured by returns. Studies have shown that when it comes to long term goals such as retirement, the time at which you start saving and the amount you put away have a greater bearing on your final corpus than the return that your investment earns. In the organised sector, retirement savings are compulsory, automatic and the quantum is linked to the income. As the income of the investor goes up, so do his savings.

In fact, superannuation benefits alone can fulfil the retirement needs of an investor if he is disciplined. If one starts putting 2,500 a month in the PF or the NPS at 25 (with a matching contribution from his employer and a 10% increase in salary every year), even a modest return of 8% will grow his corpus to 2 crore by the time he retires at 60.