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How should you go about planning for your child's future? - Outside View by PersonalFN
 
 
How should you go about planning for your child's future?

"If there must be trouble, let it be in my day so that my child may have peace" - Thomas Paine.

As rightly stated by Mr Paine (a famous English-American political activist, author, political theorist and revolutionary), this is what every parent wishes for. As a parent, you not only want your child to have a sound education, but also celebrations on important occasions for your little one, not to mention a grand wedding. But in order to fulfil these desires, it is imperative that you follow the right approach towards planning for your financial goals.

While planning for your child's needs, it always pays to start early. This is because if you start saving and invest early, it will give you a larger time horizon to meet your financial goals (such as child's education and marriage) and even build a bigger corpus.

Consider the following examples:

Example 1). Mr Shah has a 3 year old son, who is going to graduate after 15 years. Mr Shah intends that his son should pursue engineering. If the cost of graduation in today's terms is Rs 5 lakhs, then how much is Mr Shah going to need to send his son to engineering college after 15 years?

Son's Age 3 years
Cost of Education in today's terms Rs 5 lakhs
Time left for Graduation 15 years
Inflation Rate 10% p.a.
Cost at time of Graduation course Rs 20.88 lakhs
Amount Mr Shah needs to invest per month Rs 4,180

The cost of education after 15 years rises to Rs 20.88 lakhs due to inflation. And an investment of Rs 4,180 every month (assuming it earns a return of 12% per annum) will help Mr Shah to realise this financial goal. However, if Mr Shah delays this investment, and starts to invest for his son's education after 5 years from now, then he would need to invest more than double i.e. Rs 9,079 per month.

Let's take another example...

Example 2). Mrs Gupta has a daughter aged 2. She wants to create a marriage corpus that should be ready for her daughter in 22 years. Currently, Mrs Gupta imagines that she would spend Rs 15 lakhs on her marriage if it were happening today. How much would she need to save for her daughter's marriage every month to get her married after 22 years?

Daughter's Age 2 years
Cost of Marriage today 15 lakhs
Time left for Marriage 22 years
Inflation rate 10% p.a.
Cost at time of marriage Rs 1.22 Crore
Amount Mrs Gupta needs to invest per month Rs 9516

The marriage expenses after 22 years rise to Rs 1.22 crore due to inflation. And an investment of Rs 9,516 every month (assuming it earns a return of 12% per annum) will help Mrs Gupta to realise this financial goal. However, if Mrs Gupta delays this investment, and starts to invest for her daughter's marriage after 5 years from now, then she would need to invest almost double i.e. Rs 18,464 per month.

Hence you see, the earlier you start investing, the less you'll need to invest each month to achieve the same amount of money at the end of the goal.

Today, most parents save for meeting various needs of their children, but it is important to understand that saving alone is not sufficient. It is vital to save an 'appropriate sum of money' and invest it systematically in suitable investment avenues. Simply, saving money in your savings bank account will not earn high returns, and might not enable you to create the necessary corpus to meet your financial goals. Hence you must select the right investment options so that your portfolio progresses towards each of the financial goal set for your children's better future.

Selecting the ideal portfolio mix (Equity, Debt, Gold) could be a daunting task for most investors. Many investors are hesitant to put their savings in the stock market due to volatility. But, you see, in the long term equities as an asset class will largely help you to create the corpus required to meet the financial goals - even after adjusting for the rising cost of living in the form of inflation. If you have a good understanding of equity markets, insights about stock-picking strategies, and sufficient time at your disposal for analysis, you could invest in equities through stocks. However, for most other investors it would be prudent to exploit opportunities in the equity markets through equity and equity related mutual funds. Therefore, if you are many years (10 years or more) away from a said financial goal (say funding your children's professional education), then you may take a greater exposure to risky asset classes such as equities. This is because you have greater flexibility and opportunity to grow your wealth. Any setbacks the portfolio suffers can be recovered with sufficient time in hand. But when the goal is 3-10 years away, you can consider balance your portfolio with investments in equity and debt instruments. A near to ideal allocation could be 40%-50% in equities, 10%-15% in gold as a hedge to the equity exposure and balance in debt and fixed income products. It is important to de-risk your portfolio when there are only a few years left for the goal. So, if the goal is less than 3 years away, you must completely avoid equity or gold, and shift 100% of your risky portfolio to debt/fixed income.

With the increasing awareness about growing cost of education and other child care expenses, a large number of companies have launched various "childcare" investment products. People often talk about buying insurance policies that will mature around the time of your child's education or marriage. These products claim to take care of most expenses with insurance cover. Before you blindly hawk into these financial products, it is imperative to understand their viability for you. Many a times, the products that you buy to meet your children's expenses, prove to be costly ULIPs or often come with higher charges (and much higher commissions to the agent who sells you the plan). Mutual fund houses too have launched products which they claim to have designed especially to take care of childcare expenses. Retaining investments for long in speciality mutual funds also doesn't always guarantee good performance and may have exit loads which can go as high as 4%. You see, one must not get carried away with the name of an investment product or a mutual fund. It is imperative to maintain your asset allocation by investing in the correct basket of mutual funds.

While chalking out your financial plans it is necessary to include a sufficient insurance cover as well. This is because the demise of the breadwinner of the family could lead to a potential setback to your child's future goals. ULIPs and endowment plans relatively don't offer adequate insurance and may not generate adequate returns either. It is vital that you keep your investments and insurance separate. The only role insurance must play in your life, is to protect you and your family from financial trouble. Hence by supplementing the investment portfolio you have created for your children with adequate term insurance, you will be able to meet your objective of protection without having to pay for heavy charges and commissions.

Key points to keep in mind
  • Before preparing a financial plan, you must evaluate your children's future needs, and then start working towards chasing those 'need based goals'. Forecast the expenses that may arise in future ( pursuing education overseas or throwing a party for your child's birthday)
  • Begin the process of saving and investing early. This will enable you to create an adequate corpus for the fulfilment of your children's desires and ambitions
  • The financial decisions which determine your asset allocation and portfolio mix should be backed by your risk tolerance level (Income, Expenses, Financial responsibilities etc.) and risk appetite (Age, Past experience etc.)
  • Never dip into the funds saved for your other priorities (Retirement, Medical expenses, Housing rent etc.) to fund you child's education. It would be sensible to plan your finances better, preferably with the help of an expert financial planner
  • Never get carried away by names of financial products. Evaluate their characteristics and viability before making any ad-hoc investment decisions
  • Always maintain an adequate insurance cover to cater to the expenses of your children (such as marriage or pursuing higher education) which may arise after your unfortunate demise
  • It is prudent to keep your investments and insurance separate
PersonalFN believes that it is possible to fulfil the dreams you have envisioned for your children without jeopardising your personal desires, with the help of sound financial planning and suitable asset allocation.

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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