How To Plan For Your Child’s Future With Mutual Funds?

How To Plan For Your Child’s Future With Mutual Funds?

With cost of higher education shooting up, fixed income return options are unlikely to help you save for your child’s future. You need to aim for equity returns.

People usually save either for retirement or with a specific goal in mind. One of the goals is children’s future like education or marriage, while other goals could be to buy a house, car amongst others. This article focuses on the children’s future as a goal.

There are 3 key variables that you broadly need to keep in mind when planning for children:

• The amount you may need for the child’s education (and marriage)
• Years left to the event
• Return expectation to build in

This will determine the monthly or annual figure you need to set aside to meet the goal.

We illustrate the interplay of the above 3 variables with the following table, where we are planning to save Rs 75 lakh by the time the child turns 18:

Understanding this example

As you can see, there is a vast difference in the monthly amount you need to save, with difference combination of years left, and returns you will earn.

So our first advice to you is to start early. If you start investing for a child when you marry, you may have as many as 20 years ahead of you. But if you start when the child is say 5 or 8 years old, then you could be left with barely 10-12 years. The more the years you have, the less you need to set aside on a monthly basis.

The other critical part is the return your savings are generating. It is common to find parents investing in fixed deposits or Public Provident fund(PPF) to sponsor their children’s education or marriage. 

While as an investment option it is safer, it also generates paltry returns of 8-9% per annum. While interest on PPF is tax-free, that on fixed deposit is taxable, which pulls down the post-tax returns even further. Given the rate at which cost of higher education is shooting up in the country, debt definitely seems an investment option not worth considering.

As against this, if you try to aim for equity investments, your returns could be between 12-14% per annum, which is the bare minimum returns equity markets show over long periods. Given the long term horizon, short term market swings are unlikely to affect your final return, and chances of making true equity returns are higher. As your approach the last 2-3 years of the child’s educational needs, you can choose to shift the portfolio towards debt, to eliminate any volatility risk – though this would not be a major consideration as the requirement for funds would be spread over a 3-4 year period.

Why Rs 75 Lakhs?

Rs 75 lakhs may sound like a large number, but remember that with normal inflation, costs double every decade. In addition, inflation in education related expense is expected to be higher than average inflation and therefore even the Rs 75 lakhs, in about 20 year time, is not a large number.

How can you go about your investing in Equity for this purpose?

Many parents prefer to open an investing account in the name of the child, in order to isolate the account, accommodate for gifts in the name of the child, and for tax reasons. If you plan to save in the name of the child, note that you cannot open a demat account in the name of a minor, and therefore the route to equities will have to be through a Mutual Fund.

Investing independently into equity funds over such long horizon requires keeping track of performance and weeding out of underperforming schemes. If you are not up to regular monitoring of funds, then you need to seek help of financial advisors, who will do it for you, but you need to trust their subjective judgment.

Happy Investing

Source:Scripbox