Tag: You Owe it to your Children

19 Apr 2012
YOU OWE IT TO YOUR CHILDREN

YOU OWE IT TO YOUR CHILDREN – PART 2

In Part-1 of this article, posted 4 days back, we had dealt with planning for the children for the long term wherein general strategy and points to be kept in mind had been discussed.

As already brought out, one needs to start saving as early as possible. This has four huge advantages – you only need to save a small amount regularly, you are able to ride out the periodic ups and downs easily as there is enough time-cushion available, mid-course corrections can be easily implemented and most importantly, power of compounding works for you in an astonishing manner.

Having understood this, the most important question that faces you is how and where to invest? When the parents think about the child’s future, the primary thoughts are about their education and marriage. Most parents are aware of how expensive higher education has become today and compounded by Inflation, it would be out of reach of many if not meticulously planned for. This is the primary reason that most of them want to start saving so as to create enough resources to give their children dream education. This may even include higher education abroad. In this article, we will deal with these aspects specific to your child, taking age-wise scenarios.

Characteristics of Various Investment Products

There are a bewildering variety of products available in the market, each one of them catering for a specific need which should be carefully understood. If we use a good product for something it is not meant for, it is bound to fail us – you cannot use a gun to kill a fly or a butter-knife to cut wood! The products that can be used for planning for your child along with their general characteristics are as below:-

  1. Life Insurance – As the name suggests, it is meant for insuring life and not for saving. Generally, traditional policies, like money-back and endowment plans, give you returns in the range of only 6-7% per annum which is much less than inflation itself. One should not expect it to create wealth for you in the long-term. Unit Linked Insurance Plans (ULIPs) can be equity market-linked but their high upfront loading combined with barriers in switching out if they do not perform, make them unsuitable compared to other products for meeting long-term goals. ULIPs would give you decent returns only after about 6-7 years of continuous investment.
  2. Debt Products – These fixed-return products like Bank FDs, Recurring Deposits of Banks and Companies, Provident Funds (PPF, DSOPF, EPF etc), Bonds and Debt Mutual Funds, generally give you returns equal to inflation. This implies that it is likely to fare better than Life Insurance, but will only preserve your capital. Eg, if PF rate is 8.6% pa today, the inflation is also on the same lines. Your Rs 100 in these instruments will become Rs 108.60 next year, but then price of everything will also increase to that amount next year. Thus, the purchasing power of your money in these instruments has practically remained the same! However, the safety and security of capital provided by these instruments is a big plus. Therefore, some amount of your savings for the child should go into such safe instruments too.
  3. Gold – While Gold has had an unusually good run in the near past, it has largely been due to the unstable economic conditions in large parts of the developed world, which may or may not be sustained in future. Traditionally, Gold has at the same rate as inflation in India and thus, is considered a long-term hedge against inflation rather than a wealth builder. Also, to look at it as something which will fund a child’s education or marriage may not turn out to be so since normally Gold in Indian households does not get sold to fund goals except marriage!
  4. Real Estate – Real estate has the potential to give good long-term returns provided a good property is identified well in advance. This can be tricky but plenty of success stories abound. However, own Home and a second property to provide good rentals to take care of your Retirement Planning take priority while using this route to plan for your goals. The bulk investments required in real-estate may also be a deterrent and not be very conducive to using your small monthly savings. There is sometimes a tendency to concentrate all resources in this asset class, which is not a good long-term strategy and can bounce back.
  5. Equity-Linked Products – It is a well-known fact that Equities (ie, stocks or shares) and equity-linked products like Equity Mutual Funds (MF) outperform all other asset classes over the long term. If you lack the expertise to invest in equities directly and/or find yourself unable to follow the turbulence of stock markets and take timely corrective actions like exit/ additional purchase/ rebalancing, take the MF route. MFs are one of the best regulated instruments in the market today, they don’t need your day-to-day involvement, offer excellent long-term returns, are very liquid and lend themselves to small regular contributions. Maximise your exposure to such instruments for achieving the education and marriage goals of your children and keep putting the excess away in them as your income increases. However, remember that you should be comfortable with the short-term volatility of such equity-linked products before you take this step.

Prescription for your Child as per the Age Bracket

The first and foremost requirement remains taking an adequate Term Insurance Cover for yourself so that your child’s future remains safe – with or without you around. The future insurance need has to be carefully calculated in terms of amount and time-period and insurance cover already taken to be subtracted from it. Remember that the tendency to look for ‘returns’ or ‘money-back’ from an insurance policy is self-defeating – you do not expect money-back from your car insurance, then why from your life-policy? Such ‘returns’ only make it unacceptably expensive.

Child 0 to 6 Years:    There is plenty of time available for saving for your child and is, in fact, the ideal time to start. Nothing will work as well as Equity-linked products here. While debt products will provide safe option, you will not be able to meet the goals as comfortably or surely by investing only in them. Depending on your risk-taking capability, you should take a mix of the two in a ratio of anything from 0:100 to 40:60 for debt:equity products to reach your goals.

Child 6+ to 12 Years: Whatever is true for above age bracket holds true here too, the only difference being that goals are closer now. The debt:equity ratio essentially remains the same. Rebalancing and constant monitoring of the equity-linked products continues to be very important here too to create the required wealth. Adequate Term Insurance, if not already taken, remains a necessity.

Child 12+ to 18 Years: Now the education goal could be very close, maybe less than 3 years away for Graduation. There is a need to consolidate and preserve the gains made in equity / equity-linked MFs now. Hence, the money earmarked for Graduation studies’ goal should be moved gradually to debt products while that for the Post-Graduation and marriage goals should continue to grow in the equity / equity-linked MFs.

Child 18+ to Pre-Earning Years: The Post-Graduation goal could also be coming closer and the money earmarked thereon should be moved to safer avenues. Marriage expenses may continue to be invested in equity-linked products if there is still adequate time available – at least more than 3 years.

Earning Child: The child should start taking the burden of his/her future expenses now, including higher studies. Since the age is young with plenty of earning years to go, the investments should primarily be in equity-related products except for some debt products like PPF, where safe tax-free returns build up gradually and counter the volatility of equity products to some extent. Systematic Investment Plans (SIPs) in equity-diversified MFs would work the best here. The child should be encouraged to start his own investments now.

The End-piece

A child brings a lot of joy and happiness to the family. But with this also comes the realization of responsibility of parents towards them. A lot of dreams emerge with the child being the centre of those dreams. From here originates the need to create a financial base that would ensure the future of the child in all respects. It is essential that investing decisions are taken with due deliberation – seeking professional help would benefit you far more than it would cost you in the long-term. Investing portfolio for the child should be diversified to accommodate the positive points of each asset-class as also to de-risk it. Equally important is its periodic review and rebalancing. Remember, there are no automatic ‘fire-and-forget’ solutions and nothing but the best should accrue to your child!!

With regards,
Col (retd) Sanjeev Govila, CERTIFIED FINANCIAL PLANNERCM,

CEO, Hum Fauji Initiatives,
Your long-term partner for wealth creation

 

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15 Apr 2012
You owe it to your children

You Owe it to your Children – Part 1

Saving for your child’s future needs is one of your most important goals in Life

 as also your Bounden Duty as a parent

Remember Farhan Qureshi in the 3 Idiots? His father planned out his education and career the day he was born. The senior Qureshi’s career choice may have been out of sync with his son’s passion for wildlife photography but the underlying objective — to secure the financial future of his child—was bang on target. An increasing number of Indian parents are doing that today.

According to the survey, 63% of the 1,908 respondents said they started saving for their children’s education when they were born. Another 9.2% had started even before the kid was born. That’s good news, because the earlier you start, the more the time available for your investments to grow, and the bigger the corpus. But are Indians choosing the right options when investing for their children? Here’s the bad news. An overwhelming majority is opting for low-yield instruments. Almost 45% of the respondents in survey said they invest in the Public Provident Fund (PPF) and fixed deposits for their children. Another 38% have invested in traditional insurance policies.

“Despite the numerous options available, Indian parents continue to rely on bank fixed deposits due to lack of awareness,” – laments a Financial Planner. The encouraging part is that 43% also invest in equity mutual funds and stocks for their children, while 26% have opted for child insurance plans that provide for the education of the child if the parent is no more. The skew towards low-yield products also means that many Indian parents might fall short of the targets they have set for their children’s investments.

Estimated that in raising a child in urban India from cradle till college costs roughly Rs 55 lakh. The calculation assumes that the child will take up a professional course costing Rs 10 lakh. This is the cost at today’s prices and the amount has to be adjusted for inflation. Now comes the scariest part. Education costs, which constitute nearly 46% of the total expense on a child, are growing at a worrying pace of 20-25% per year.

Formulating a Strategy:

Fortunately for parents, there are enough investment products to help them fulfill the dreams for their children. Chosen appropriately, these options can help you save enough to send your daughter to the best medical college in the country, or book a ritzy 5-star hotel for your son’s wedding. How does one choose the right product? The first thing to understand is that there is nothing to differentiate the investments made for children from the rest of your portfolio. They are exposed to the same risks, offer the same returns and are taxed at the same rate. No mutual fund will give units at a discount or offer guaranteed returns just because a parent is saving for his child. No bank will offer you a higher interest rate. No insurance company will charge a lower premium. The taxman too will not exempt any income. So, the same rules that govern your own investments should apply to those made for your children.

Your choice should depend on four basic factors: the tenure of the investment, the risk you are willing to take, the returns offered by the option and the taxability of the income. Here’s how these four factors can affect your investments.

Tenure of investment: Are you saving for your daughter’s education? Or for your son’s marriage? Financial planners say it is best to define your goals and segregate the investment for each goal. “Since each goal has a different time frame, separating them will allow the parent to choose the most appropriate investment to reach that goal,” The stock market has historically been the best place to park your money for the long term. There are enough studies to prove that equities give the highest returns in the long term.

Risk and returns: Every individual has a different risk appetite. Equities are certainly a great option for creating wealth over the long term, but what good is this money if it leaves you tossing and turning in bed, agonising over how your investments are faring. So choose an option that suits your risk tolerance. For this, first get your risk profile assessed by a financial planner. In many cases, one does not even know how much risk he can take. “Most parents adopt a very conservative approach when it comes to investing for their children. This attitude is rooted in the choices their parents had made and is difficult to shed.

Higher the risk you are willing to take, the higher your returns could be. Then again, your ability to take risks depends on the time available. As we mentioned earlier, stocks and equity funds work best for long-term goals. However, if you are saving for your son’s marriage in 2013, steer clear of volatile stocks and put the money in a debt fund, or even a fixed deposit.

Taxability of income: Keep in mind the income tax rules that apply to your investments. Your child’s income is actually your own. This is also the reason why PPF and insurance policies are so popular with investors. The income from these options is tax-free, but there are other tax-efficient options as well. For instance, the income from equity and equity-oriented mutual funds is tax-free after a year. Investments in other funds can help you defer tax for years, even decades.

When you take into account these factors, the investment portfolio for your child becomes a mix of short-, medium- and long-term products. Each option has something to offer, some financial goal to achieve. Fixed deposits offer safety and assured returns but won’t be able to beat inflation. Mutual funds offer high growth but carry a risk and don’t offer any insurance cover. Child insurance plans offer an insurance cover and help the wealth to grow but levy high charges. Gold helps fight inflation but doesn’t offer diversification.

Excerpts from an article in Economic Times, 18 April 2011

 

Just to substantiate the article above, a calculation primer for all:-

High Risk, High Returns – A monthly investment of Rs 10,000 will grow to:

Rate of Interest @ 8% @ 10% @ 12% @ 15%
In 5 Years     Rs 7.32 Lakh     Rs 7.76 Lakh     Rs 8.02 Lakh     Rs 8.62 Lakh
In 10 Years Rs 18.02 Lakh Rs 19.98 Lakh Rs 22.02 Lakh Rs 26.02 Lakh
In 15 Years Rs 33.76 Lakh Rs 39.84 Lakh Rs 47.14 Lakh Rs 60.92 Lakh
Equity Portion 0% 10-15% 35-50% 80-100%
Risk Nil Low Moderate High

(The next article to be posted on Wed, 18 April 2012 will give out the suggested financial instruments and planning you should do for your child(ren) depending on their present age)  

 

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