10 November, 2009

Planning for Child's future

Planning for the child’s future is something close to the heart of most parents. So it was for Neha. She started worrying about her four year old son Roshan & her 6 month old newbie, Puja. She was getting psyched by the enormous sums being demanded as “donation” for admitting kids in school. They had paid Rs.75,000/- for Roshan’s admission, after much negotiation and using their contacts. The fee for him per month works out to Rs.2,500/-. This does not include book, uniform , picnics etc. And then, there were the other expenses for activities like skating, swimming, karate etc. No wonder, she was worried. In about three years Puja will also join the school. The expenses will then be quite a packet.
It is a fact that Avinash, her husband, was earning decently. At 32, he still has a long working life & a promising career ahead of him. His take home at Rs.45,000/- pm is decent. But Neha was worried as there are all those EMIs & expenses, which puts a strain on the purse. Many times, they stare at an empty void in their moneybox, at the end of the month.
What scares the daylights out of Neha is the children’s education expenses. She has heard about the galloping education expenses which can top 10% pa. Also, the college fees these days get revised year- on-year, in quantum jumps – which makes planning for future, that much more difficult. Add to that the fact that the child may pursue Arts / commerce/ Engineering/ medicine…which is not clear right now. Hence, what amount to provide for, for education needs of the child becomes tricky.
As financial planners, this is familiar territory. Let us help Neha in planning for her child’s education needs.
1. Lot of people gravitate towards child policies, as if it is a panacea that will somehow take care of the education requirements of the child. Child policies are nothing but money back policies, where the return on investments tends to be low. In case if the same policy is unit-linked, it looks broadly similar to a Mutual Fund scheme. Some child policies have unique features like Income benefit, which is typically a rider. If the parent were to pass away, the family will start receiving a portion of the sum assured back ( say 10% pa ) till the end of term. This could be useful to enable the child to complete the education. But one could also take a term plan. On demise, it could give a sufficient corpus to enable the child to complete education.
Hence, child policies can be one part of the planning. Term plans also can be considered to hedge the life risk of parent.
2. The other part of the strategy is to invest in child plans from Mutual Funds. Most of them are balanced funds. There are those which allocate more towards debt & others that allocate the bulk towards equity. These are available across Mutual fund houses and can be chosen in line with the overall strategy.
3. There are those who are conservative in their outlook and want to accumulate the education kitty in safe investment options. They have PPF, Recurring deposits, Bank Deposits, KVPs etc. Though safe, the growth of the corpus is also rather modest. Hence, this again cannot be the only way to build the child’s education corpus.
4. Mutual Funds can give excellent returns, over a long time frame. A lot of people get unnerved by the short term fluctuations that are endemic to the stock market. But the risk of losing money comes down when held on for a longtime. In fact, Mutual Funds have the potential to deliver a 12 – 15% pa returns, in the longterm ( about 10 years ). One can also invest in Equity. The risk profile here is higher and is recommended for those who can stomach the risk and who can get good advice on investing in stocks.
It is very easy to project what will be the future cost at an assumed inflation factor ( say 8% ) for education – Rs.6 Lakhs needed today would be Rs.25.9 Lakhs. Projecting for such long-terms, is fraught with danger – the child might end up doing a course requiring lesser or more money by way of education expenses, inflation rate could be off the mark, investment returns could be different from the one assumed or it might become difficult for the parent to consistently put aside the required investment every year. Hence, when a plan is created, it is a good idea to revisit the plan every year so that any changes can be incorporated and the plan can be brought back on track.
The most important part is to start off. When such planning happens early, the amount to be put aside is small. For instance, if the target amount after 19 years is Rs.25 Lakhs, she needs to put aside only Rs.4,696/-pm ( assuming 8% returns ). The amount goes up to Rs.13,665/-pm, if the savings tenure is 10 years – about 3 times more.
Let us now look at what might be helpful for Neha. A 50-60% allocation is recommended towards Equity MFs. Equity diversified funds ( with Large to Midcap orientation ), Index funds, balanced funds & a small exposure to Gold ETFs ( 5-10% of the MF allocation ) could make up this portion. A 30-40% allocation can be made to the debt investment options – like PPF, Bank Deposits, Recurring Deposits etc. A 10-20% allocation can go to insurance plans depending on what kind of plan is being contemplated – Term or a child plan. Her Puja should bear fruit now with roshan all around!

Published in Moneycontrol on 26th Oct., 2009

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