You Owe it to your Children – Part 1

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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