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How to plan for your child's higher education - Outside View by PersonalFN

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How to plan for your child's higher education
Feb 6, 2012

As a concerned parent, the main thing you want to do for your child is help them get ahead in life. Regardless of how old your child is, it's never too early to plan for his or her higher education. Especially considering that a good education is one of the best assets you can give your child, and education fees are only going to go up. This is why the earlier you create a plan for your financial commitments, the better.

Consider the case of our favourite fictional character, Mr. Shah. Mr. Shah has 2 children: his son is aged 15 and his daughter is aged 10.

He wants to plan for both their graduations at age 18. Hence for his son he has only 3 years to create an education corpus and for his daughter he has 8 years.

Let's see what steps Mr. Shah has to take to fund these life goals.

Step 1: Know What You Need to Achieve

The first thing Mr. Shah needs to do is figure out approximately how much each child's education is going to cost him - a conservative estimate and an aggressive estimate.

Let's see how he can do this.

Each child might decide to pursue their graduation in India, or abroad. Let's see what the conservative and aggressive estimates might be in these cases.

Consider a Bachelors degree from a premier college in a metro city in India.

The fees would be approximately up to Rs. 1.50 lakh per year, considering tuition fees, books and materials and so forth. Considering 3 years for the Bachelors degree, and factoring in miscellaneous expenses like additional tuition classes that might be required and so on, we can round the fees up to Rs. 10 lakhs in today's terms.

Now consider a Bachelor's degree from a premier university abroad. The fees here would include not only tuition, books and materials but also flight, visa, boarding, living expenses and so forth. 3 years abroad would cost upwards of Rs. 90 lakhs in today's terms.

When you factor in inflation, these figures grow even more.

  Current Age Graduation age Years to goal Current Cost Inflated cost at time of goal
        Aggressive Conservative Aggressive Conservative
Son 15 18 3 9,000,000 1,000,000 11,979,000 1,331,000
Daughter 10 18 8 9,000,000 1,000,000 19,292,299 2,143,589

Now Mr. Shah knows that the least he will need for his son is Rs. 13.31 lakhs and the most he might need is Rs. 1.20 crore. Similarly, for his daughter, he will require a minimum corpus of Rs. 21.43 lakhs, and a maximum corpus of Rs. 1.93 crore. (Inflation assumed at 10% per annum).

The objective of calculating these numbers is not to scare you dear reader, but to make you aware. These numbers will help to reinforce the point that for your children's goals, such as education and marriage, the best time to start planning and investing is as soon as you have children.

Step 2: Assess Existing Assets

Suppose we are considering achieving the maximum corpus for Mr. Shah's son i.e. Rs. 1.20 crore. To achieve this figure, if Mr. Shah were to invest only in debt for the next 3 years considering the risks in equity, he would have to invest Rs. 2.98 lakhs per month into a debt mutual fund, earning a 7% post tax return per annum. This is not feasible considering that Mr. Shah has other goals that he also needs to invest for, the biggest one among these being his own retirement. So we should first see what investments are already available that can be mapped to this particular goal.

Luckily for Mr. Shah, he had the foresight to invest into his son's PPF which is close to maturity. He has religiously been investing Rs. 70,000 per annum starting in the year his son was born, and the corpus has now grown to Rs. 21.62 lakhs. (Note: The rate of interest on PPF was 12% in 1997, and has thereafter reduced to 8%. It currently stands at 8.60% for the present year.)

He has also been investing in diversified equity mutual funds to the extent of Rs. 10,000 per month each for his son and daughter, starting when they were born.

His son's corpus has grown to Rs. 67.68 lakhs over the last 15 years and his daughter's corpus started 10 years ago currently stands at Rs. 27.86 lakhs.

Thus the total assets available for his son's education corpus are:

PPF Rs. 21.62 lakhs
Equity Mutual Funds Rs. 67.68 lakhs
TOTAL Rs. 89.30 lakhs

Step 3: Rebalance and Keep Investing

Mr. Shah's son will need the funds for his graduation in 3 years.

At PersonalFN, we believe that if you have 3 years or less to fund a particular goal, you should not invest in equity. The risk to principal where equity is concerned is very high, and with 3 years left for a goal you might not have time to rebuild eroded principal. Hence, debt investments are the way to go.

The existing Rs. 67.68 lakhs of equity mutual funds and PPF maturity amount of Rs. 21.62 lakhscan be shifted to a safe debt instrument yielding at least an inflation-matching post tax rate of return of 7% per annum which will become Rs. 1.09crores after 3 years, and the fresh investments over the next 3 years can go into a well-researched portfolio of debt mutual funds.

Assuming Mr. Shah invests another Rs. 10,000 per month for the remaining 3 years into a debt portfolio yielding 7% per annum post tax, his fresh investments will provide an additional corpus of Rs. 4.02 lakhs.

This brings his total corpus to Rs. 1.13crores.

He still needs another Rs. 6 lakhs approx.to fund his son's education.

For his, in order to not let his other goals suffer to a great extent, Mr. Shah's son can opt for an education loan of Rs. 6 lakhs, which he can repay on his own after his graduation. If required, Mr. Shah can assist, factoring in the EMIs into his own cash flows and ensuring correct cash flow management with the help of his expert financial planner.

In this manner, Mr. Shah can achieve even the aggressive estimated education corpus figure. If his son decides to pursue his graduation in India, the surplus assets can be rebalanced for another goal, depending on the new goal's remaining time horizon.

The same steps can be followed for Mr. Shah's daughter. Since the goal is 8 years away, he can with expert help build a solid portfolio of equity mutual funds for this goal and invest in it regularly.

The same steps can be followed for Mr. Shah's daughter.

Conclusion

As with any life goal, the key thing to do is start as early as possible. This will help you to build up a corpus diligently over time and will save you from any financial stress that you might otherwise suffer.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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