Saving for your child's future (be it for their education and/or wedding) is one of the most important
financial goals for a parent. That is why it should be done with the most care and research and not on ad-hoc planning.
Many parents are in a fix as to how they should invest for their children especially regarding the
investment avenues they should use.
If you too are in a spot as to where you should invest, read on to find about the three financial products you can consider for your child's long-term needs.
Before you start investing
To avoid making hasty financial decisions or abruptly changing investment strategies, prepare early to meet the child's financial needs at different stages of life. Identify and estimate (after adjusting for inflation) the child's goals with different time horizons and then start saving for it.
For instance, growing at an inflation rate of 6 per cent a year, an engineering course that costs Rs 4 lakh presently will cost around Rs 10 lakh after 16 years. So, at a growth rate of 15 per cent, you need to put aside around Rs 1,300 per month to reach that goal. Similarly, a two-year, full-time MBA course at a prestigious institution that costs around Rs 11.50 lakh for two years would cost around Rs 40 lakh after 21 years. Assuming that the equity market would grow at 15 per cent compounded annualised, you will need to put aside Rs 2,233 per month to reach that amount.
Children's Day: How to invest correctly for your kid's goals
Dilemma: Every Indian parent's middle name
14 Nov, 2018
Most parents blindly tread the investment terrain and randomly put money in disparate instruments due to ignorance and wrong advice.
The first step to building a corpus for your children is to frame clear goals, with defined future values taking inflation into consideration. Then fix correct time horizons for these. Time frame and risk primarily decide where to invest. The second step is to build a portfolio with the right asset allocation to ensure growth and safety of your investments keeping in mind your age and goal horizons. Finally, pick the instruments that fit into this asset allocation.
Q1. Which mutual fund should I invest in for child’s goals?
14 Nov, 2018
Most people have the discipline to start investing but find it difficult to continue. There are funds for all goals— short-, medium- or long-term, but one should know which funds to use for which goal.
For long-term goals, equity or diversified equity funds that invest nearly 80% in equity can be considered. This is because these will give high returns of over 12% and the risk is virtually negligible after 10 years. You can also go for an ELSS, which is a diversified equity fund. It offers tax benefit under Sec 80C and has a lock-in period of three years. For medium-term goals, pick balanced or hybrid funds, which invest in equity and debt typically in 60:40 ratio. For short- term goals of 2-3 years, pick short-duration debt funds since these offer safety of capital and higher interest than bank accounts.
Q2. Is an education loan better than tapping retirement corpus?
14 Nov, 2018
Parents end up expending all their financial resources, even mortgaging their homes and risking their retirement to fund the kid’s education.
A good option is to take an education loan, since it keeps your retirement corpus safe, does not impact the household cash flow and the repayment process incurs responsibility in the child. Another advantage is the tax benefit since the interest portion of the loan is eligible for deduction under Section 80E of the Income Tax Act. Education loans are easily available, both for Indian and foreign higher education. The interest rates start at 8% and no guarantor or collateral is required for loans below Rs 4 lakh. There is grace period of one year, as mandated by the RBI, after the child finishes his education and starts repaying the loan.
Q3. Should I buy real estate to fund my kid’s life goals?
14 Nov, 2018
Real estate investment is risky for many reasons. There are various attendant charges that you incur too, like property tax, maintenance cost, high transactional costs or capital gains on selling it.
Real estate is not only illiquid in nature, but also indivisible. Instead of this, it would do the parents well to invest in a balanced fund to yield a bigger corpus. Even with rental income, the value of a house is bound to fall way short of the corpus that a balanced fund can help you amass in the same duration.
Q4. Should I buy a child Ulip or go for an endowment plan?
14 Nov, 2018
Ideally, neither should be in your portfolio because both are insurance plans. Endowment and money-back policies are best avoided for both children and adults because these are obscure and give low 4-6% returns. They are also expensive due to high mortality charges and offer a low insurance cover. A prudent option is to go for a combination of a term cover and mutual fund investment. Mutual funds offer much higher returns and are more transparent compared to child plans.
However, if you are looking at securing and supplementing the mutual fund corpus while securing your child’s long-term goal, opt for Ulips. The new avatar of Ulips offers returns comparable with mutual funds and low charges.
Here are three investment products that may be used in combination to meet your kid's financial goals over the long term.
1. Public Provident Fund (PPF)
PPF remains a time-tested investment for over several decades now. Two factors that make PPF an effective tax saver for the long term are: tax-free annual interest that is earned and the annual compounding. As the interest declared and added to the account including the principal invested is backed by sovereign guarantee, it lends highest safety to the PPF investment.
A PPF account can be opened in one's own name as well as in the name of a minor. However, a maximum of Rs 1.5 lakh can be put into them (parent plus minor account) in one year. The principal invested in PPF qualifies for deduction under Section 80C of the Income Tax Act, 1961 up to a maximum limit of Rs 1.5 lakh in a financial year. Investment made in self and kid's account will both count towards tax benefits.
Further, PPF has a long tenure of 15 years, thus the impact of compounding is huge, especially in the later years. In addition to one's own account, open an account in kid's name and keep contributing into both of them. When the child becomes a major and starts earning, he or she can continue it in their own name. The biggest advantage is that the lock-in period (of minor's account) will no longer be 15 years as it was already opened by the parents long back. The child can, however, extend the account in block of 5 years indefinitely, invest to save tax, and reap tax-free proceeds.
Also Read:
Why opening PPF account for minors can be beneficial for them
2. Sukanya Samriddhi Yojana (SSY)
The government-backed Sukanya Samriddhi Yojana is targeted towards a girl child and her financial needs such as education and marriage.
An SSY account can only be opened in the name of a girl child (beneficiary) below 10 years, as on the date of the opening of the account. The rules allow for the opening of a maximum of two accounts for two girls in a family. One can't open two accounts for one girl. When the beneficiary, i.e., the girl child crosses the age of 10, she can operate the account on her own. She can make any future contributions to her own account. The parents, too, can continue to deposit in the same account.
A window for withdrawals is allowed when the girl turns 18. A maximum of 50 per cent of the account balance of the preceding year may be withdrawn for the purpose of higher education of the girl.
Also Read:
How to open a Sukanya Samriddhi Account | Step by Step Guide
Irrespective of the age, the SSY account will run for 21 years from the date of its opening. So if the girl child's age is 9, the scheme will mature when she turns 30. The rules, however, permit final closure anytime before 21 years if the parent files an application for such premature closure for the purpose of her marriage and confirms through an affidavit that the applicant is not below 18 years on the date of marriage.
SSY carries the highest tax-free return with sovereign guarantee and comes with the exempt-exempt-exempt (EEE) status. The annual deposit (contributions) qualifies for Section 80C benefit and the maturity benefits are non-taxable. SSY can be opened in a post office or a bank. One can also make deposits through electronic means, i.e., e-transfer to the concerned post office or bank if either has access to the core banking facility.
To open an SSY account, a minimum initial deposit of Rs 250 (earlier it was Rs 1,000) is required. Thereafter, a minimum of Rs 250 (earlier it was Rs 1,000) up to a maximum of Rs 1.5 lakh can be deposited in the account annually. To keep the account active, deposits need to be made only for the initial 15 years
Equity mutual funds with equities as the underlying asset class have the potential to deliver high inflation adjusted returns over the long term. When it comes to planning for your child's needs which are around 10 years away, stick to large-cap funds as they invest in well-established companies and are, therefore, less volatile. They give reasonable gains when equity markets rise and are also comparatively less volatile when the market falls.
Mid-cap funds are known to have sudden spurts in their performance but are also prone to sudden dips if market conditions turn excessively volatile. One may also opt for consistently performing multi-cap schemes with established track record. A more passive way will be to choose index mutual funds. Overall, one should not have more than 3-4 funds earmarked for their child's needs.
Also Read:
How to fund your child’s education through mutual funds?
With time on your side, investing in equity has many advantages. But, you need to keep a close eye on the markets once you are less than three years away from your goal. One needs to derisk the portfolio as you are near your targets to ensure that whatever gains you have earned so far do not get wiped out. In other words, as you near your target, start shifting from equity to debt, so that your gains move into a safer area.
What you should do
Once you have estimated monthly savings towards your child's goal, depending on your risk profile, the investments can be divided among PPF, SSY and equity mutual funds. Don't just bank upon any one of these products unless your risk profile allows.
While PPF and SSY are debt investments, the latter most represents equity asset class. Also, PPF and SSY have a fixed tenure and a lock-in period that needs to be taken into account while investing in them so as to link them to the child goal. Choose equity MFs that are open-ended and thus provides flexibility in reaching the goals.