Alice : Which road is the right one to take?
Cheshire Cat : Depends on where you want to go.
Alice : I do not know!
Cheshire Cat : Then any road will get you there!
– Alice in Wonderland
Financial planning for your children is probably something that takes up a lot of your ‘worrying’ time. You know that you need to start setting aside money for your child’s needs. But what you do not know is the ideal way to go about doing the same. Whether your objective is to provide for your child’s education, marriage, property or seed capital for a business venture for your child, the approach given here holds good. The key lies in identifying each objective that you wish to provide for in an unambiguous manner and then quantifying it. While planning for your child’s future, there are some thumb rules that you should bear in mind which are given as a list of do’s and don’ts later in this article.
Why is this exercise more strenuous for Armed Forces Officers
Due to the nature of the profession, wherein there is constant movement from one end of the country to the other and even abroad; when one does stop for a short while, it is in some unpronounceable place in the middle of nowhere; in the name of a financial advisor or facility, there is a semi-educated insurance agent available, if at all; the stress and strains of the job keep own well-being far away from the mind; etc. All these issues combine to make a potion which keeps any thoughts of own planning far away from own conscious. The result is a sudden jolt-like awakening when the requirement is not merely knocking, but loudly banging at the door. Thus, in spite of all diversions, constraints, lack of adequate knowledge and facilities etc, one has to keep at it, come what may. After all, the duty towards our families has to take a priority somewhere high up on the scale.
Concept of Financial Planning
Before venturing any further, it is pertinent to note that financial planning is a much personalised activity. It will work best for you only if there is customisation to suit your exact needs and profile. Also to be noted is the fact that financial planning is not a one-time activity. Making of the plan is only the start of what is going to be an ongoing activity for many years to come.
The table below compares investment strategies followed by three parents as per their risk profiles. The point to see is that, the parent, who is willing to take higher risk, would ideally be compensated by a higher return – the portfolio will have a higher concentration of risky assets like equity mutual funds or Unit linked Insurance Plans (ULIPs) with high equity exposure. Such a portfolio can earn a return of about 15% CAGR (Compounded Annual Growth Rate). At the other extreme is a risk-averse parent, who is investing only in schemes like the DSOPF/Public Provident Fund (PPF) and the National Savings Certificate (NSC). Alternatively one can invest in mutual funds and ULIPs, which invest in Government of India debt instruments. A portfolio of these schemes will normally earn a return of about 5.5% CAGR over the investment horizon. The parent with a moderate risk appetite should have a combination of risky and less risky assets. We have assumed that a moderate risk portfolio can yield about 12% CAGR.
|Case 1 Aggressive||Case 2
|Cost of College Education today*||Rs||5,00,000||5,00,000||5,00,000|
|Time to College||yrs||15||15||15|
|Expected inflation in fee||%||10||10||10|
|Expected Future Cost of College Education||Rs||20,88,624||20,88,624||20,88,624|
|Money already set aside||Rs||1,00,000||1,00,000||1,00,000|
|Expected growth of assets (Post tax)||%||15.0||11.5||5.5|
|Value of existing assets at the time of need||Rs||8,13,706||5,11,826||2,23,247|
|Therefore, net to be accumulated||Rs||12,74,918||15,76,798||18,65,377|
|Monies to be accumulated…||Rs||12,74,918||15,76,798||18,65,377|
|Annual Saving of||Rs||43,897||58,323||93,206|
|Or Monthly investments of||Rs||3,658||4,860||7,767|
|Or a one-time investment of||Rs||2,56,680||4,08,072||9,35,564|
* Includes combined fee and monies for living, for Engineering and an MBA course from a rated institute in India. Tax rate assumed at 30% plus applicable surcharge.
Another factor that a parent needs to keep in mind is that any solution, where all the money is invested in one asset class, is not an advisable proposition. Coming to the solution, the first number that hits you in the table is the ‘inflated’ cost of education and living expenses 15 years from now. Indeed, if seen in isolation, you might almost give up in terms of ever having enough money to provide for your child’s education need. However, what appears impossible is not really so. For a parent with a high risk appetite, the money that needs to be set aside every month is just Rs 3,658!
Mutual Funds for Your Child
The good news for parents is that there is common ground between their objectives and the objectives of child fund schemes of mutual funds. Child funds are launched with the explicit objective of helping parents build a corpus. Sample this – one of Mutual Fund company’s Children Career Plan’s investment objective reads – ‘to provide children, after they attain the age of 18 years, a means to receive scholarship to meet the cost of higher education and/or to help them in setting up a profession, practice or business or enabling them to set up a home or finance the cost of other social obligations.’
Do’s of Planning
The ‘mantras’ given below may have to be applied as per your specific requirements and risk aptitude, though in most of the cases, their applicability is universal.
- Have a distinct plan in place for each objective Define each objective that you wish to accomplish i.e. provide for your child’s education, marriage or seed capital for a business activity. The next step should be, to have a distinct plan in place for each objective and to allocate resources accordingly.
- Engage the services of a financial planner, if not confident yourself The importance of engaging the services of an expert and qualified financial planner cannot be overstated. It pays to be actively involved in the entire financial planning activity. Your participation will not only ensure that you are unambiguously aware of how your portfolio is progressing; it will also keep the financial planner on his toes.
Don’ts of Planning
- Don’t delay the investment activity Starting early will enable parents to gain from the “power of compounding”. Say families X and Y are planning to create a corpus that will provide for their respective children’s education expenses 20 years from now. Family X, being the more proactive of the two, starts investing Rs 10,000 every year. Family Y starts the investment process after 10 years. However, to make up for the lost time, family Y decided to double the investment amount i.e. they invest Rs 20,000 per annum for a 10-yr period.
|Family X||Family Y|
|Amount invested (Rs per annum)||10,000||20,000|
|Tenure of investment (years)||20||10|
|Returns (% per annum)||8||8|
|Maturity amount (Rs)||457,620||289,740|
The substantial difference seen above can be attributed to the fact that family X had longer investment tenure and hence could enjoy the benefits of compounding. Family Y failed to match the corpus accumulated by family X, despite having doubled the investment amount. The message is simple: it pays to start early!
- Don’t dip into your child’s portfolio Resist the temptation to utilise the monies that have been set aside for the child’s future needs, for your present consumption.
How to Teach Children the Value of Money
It is unlikely that a kid will learn to manage her money until she formally takes up a career in finance. Here is what you can do in your own little way to ensure that your kid isn’t completely at sea when it comes to managing her money.
It’s never too early to start : Explain the benefits of saving money over time, and how it can provide them with the power of buying something in the future that may be well beyond their means today. Introduce them to the concept of monetary ‘limitations’ and how saving is the best way to avoid them.
Who makes money? : In every child’s head, parents are a sort of discretionary mint that decides when to grant some money and when not to. Explain the concept of ‘salary’ to them by giving them a nominal monthly allowance. Keep a tab on their weekly expenses, and let them learn their own lessons.
Show them how saving can be fun : Tell them how they will not have to pine for their favourite toy anymore, once they start saving money. Basically make them truly appreciate the merits of saving and financial planning.
Banking is an experience; let them feel it: Take your child to the bank. As soon as possible, get an account opened in their name, where they can personally experience banking.
Inculcate good shopping habits : Kids are very observant; they catch on to the smallest of habits and attitudes. If you are an impulse shopper, make sure you do not overindulge yourself in front of your children. As often as possible, make large or expensive purchases seem deliberate and planned. Rationalise purchases in their presence so that they understand the usefulness of it.
IN A NUTSHELL
|♠ Inflation, i.e. a rise in the general price level, is one of the major factors that necessitate financial planning.
♠ Financial planning aids individuals upgrade and maintain their lifestyles as also helps meet contingencies.
♠ Setting objectives is the first step in the financial planning process. Each objective must be backed by a dedicated investment plan.
♠ When faced with multiple objectives, prioritise and start off with the most pressing one.
♠ Start early and make up for any deficit at a later stage. Don’t delay the investment process on account of small shortage of funds.
♠ Always evaluate the risk in an investment opportunity before the return. Invest in line with your risk appetite, not the expected return.
♠ Market linked investments like equities get less risky with the passage of time. In fact, Mutual Funds investing in Equity (shares) are the least risky if investment horizon is beyond 5 years!!
♠ Risk is a very personal thing; there is no formula to calculate it.
♠ Often at an advanced age, risk appetite declines.
I have tried to include a large amount of tips in this small article, due to space constraints and reader-fatigue considerations. Any specific queries or advice can be sent to me on my email ID email@example.com or on tele 0 – 9999 022 033 / 011-4054 5977.