Equities and Your kid(s) - Do's and Don'ts - Views on News from Equitymaster

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Equities and Your kid(s) - Do's and Don'ts

Sep 20, 2006

How does one decide an equity portfolio to meet future financial needs of one's child and how different can that be from a regular long-term equity portfolio? Both these portfolios have an investment horizon of five to fifteen years and in both cases, one has to choose the a company with immense scrutiny because the business model of the company has to be robust to withstand ups and downs in the economy over that long a time horizon. Here is our 'Do's' and 'Don'ts' when it comes to building an equity portfolio to fund your child's education/marriage/house.First, the foundation stone...
Given the fact that there are many things that an individual has to plan for, including buying a property, saving for the post-retirement phase and funding child's education/marriage/property, it is pertinent to arrive at an appropriate equity allocation. This is critical because the child's future cannot be compromised for one's immediate financial needs i.e., one should not sell the part of equities that is allocated for your child to meet your immediate financial expenses. Otherwise, the sole purpose will be diluted. It is pertinent to identify your goals and build your equity portfolio accordingly. This is the foundation of financial planning for your child.

Of course, how much to allocate towards child's future in one's equity portfolio is dependent on individuals. But we have drawn a plan to make it simpler for one to decide. In the overall equity portfolio, since child's future should have a larger weightage because the needs are more immediate than retirement planning. For instance, for a 30 year old, having a small child, the child's higher education and marriage is 20 to 25 years down the line whereas retirement planning is 30 years down the line.

Now, the Do's while planning an equity portfolio for your child's future...

  1. Cost of living and equities: As it is known, in the long-term, the cost of living is likely to increase. Education costs, across grades, have been spiraling upwards in the last five years and are likely to maintain the momentum in the long-term. The same is the case with property and other needs. Given the fact that equities tend to be more rewarding in the long-term as compared to other asset classes (after adjusting for inflation), we believe that there is a compelling case to invest in equities for one's child future. Consult your equity advisor to draw a list of stocks for the long-term and invest only if you are convinced about the company (not just based on what your equity advisor thinks is right).

  2. Foreign education - Foreign stocks: India, being a developing economy, will depend on foreign capital to grow and to that extent, the Rupee is expected to depreciate against the greenback (the US dollar). As such, say after fifteen years, you will definitely need more Rupees to buy one US Dollar than what you need now. So, in case you wish to give quality overseas education to your child, investing in US Dollar denominated assets can be a rewarding option in the long-term. As we go forward, we believe that the doors will be open much wider for Indian investors to invest abroad (not just the US).

  3. Identify the surplus: It is pertinent to approach equities like the way we pay premium on a child policy, with at least a fifteen-year perspective. Invest only that portion of your surplus in equities that you do not need in the future. This is perhaps one of the major factors that influence the final outcome.

  4. Large-caps or mid-caps: In our view, this is an individual decision. But since you are investing with a long horizon, it is desirable to have relatively higher exposure towards large-caps to start of with. Companies like HDFC, Gujarat Ambuja, Asian Paints and SBI are names that have managed business cycles in the past very well. Yes, mid-caps can be rewarding but in our view, one has to tread with caution. Since mid-caps, by nature, are relatively marginal players or niche players, they are more susceptible to shocks, be it external (global and domestic economy) or internal (management depth and execution capabilities).

The Don'ts while planning an equity portfolio for your child's future...

  1. Equities are a risky asset class: Just investing for ten to fifteen years do not mean returns will be higher or there are no risks. The period between 1992 and 2002 was a classic example that investing in stocks need not be rewarding in the long-term as well. Also, as the Indian economy becomes more globalised, companies will be highly vulnerable to external developments (like September 11, Iraq war, SARS and interest rate movements).

  2. Never take a short-term view: Like Rome was not built in a day, it takes decades for companies like Infosys and HDFC to implement their vision. Yes, there will be short-term gyrations in terms of financial performance but in the long-term, stock prices will track earnings growth and cash flow generation, provided the management is good at execution. We suggest investors not to involve in short-term trading or investing with a six months horizon when it comes to planning for your child. It is better to stay away completely.

  3. Switching portfolios: We suggest investors not to dilute that part of the portfolio allocated for your child's future. In case of a compelling need, we suggest investors to dilute the 'others' portfolio and may be, a portion of your 'retirement planning' allocation.

  4. Review portfolio: The blue chips of the 1990s like Bombay Dyeing, Century Textiles, ACC and BPL are no longer in the limelight. As the Indian economy grows, there will be many new companies from new sectors like logistics, transportation, pharma, media, and software to invest. So, it is pertinent to review one's portfolio every year critically. As it is commonly said, do not get married to your stocks.

We hope that the do's and don'ts will enable you to plan your savings in a optimum manner to achieve desired long-term goals. Happy investing!

  • This article forms part of "Money Simplified -Planning your child's future" - a free-to-download online guide from Personalfn. To download the entire guide, please click here.

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