At any point in time, we address the immediate financial need and happily postpone the one which has time to go. We don’t realise that postponing a future need will work out more expensive a few years later than today.
Many wake up to this truth especially when close to retirement. Others do so when their kids are a few years away from their higher studies. While you have the options to either work or cut corners to meet your post-retirement needs, you don’t have much choice when it comes to your child’s future, and you surely don’t want to compromise on this front. As a result, you have to dole out huge sums of money as education cost is sky-rocketing.
Postponing financial planning for your child by five years leads to you having to shell out double the amount. Sample this, if you have 15 years to plan for your child, you should save Rs 57,000 annually, that is, around Rs 4,500 a month. If you have 10 years in hand, you should save close to Rs 1.2 lakh a year (or Rs 10,000 a month). In comparison, if you have only five years in hand, you should be ready to set aside Rs 3.35 lakh every year (almost Rs 28,000 a month) for your child (see table).
Explains Malhar Majumder, certified financial planner and executive director of Kolkata-based Fine Advice, the shorter the time horizon, the lesser the risk that can be taken. As a result, more money will have to be put in instruments which promise safety of funds over very good returns.
When you have less time in hand, how to go about saving for a goal also becomes a question, especially for a goal as important as your child’s future. Let’s assume the corpus required for three children’s future needs is Rs 20 lakh and the time left to build the corpus for each one is five, 10 and 15 years, respectively. Here’s how you can go about accumulating the sum. According to Majumder, the best instruments to put money in, in the present market, are corporate bond funds and large-cap equity funds. “Gold is also a very good asset class to invest, given the kind of returns it has generated and is continuing to do but prices are way too high,” he says.
If you have less time in hand, say five years, you will have to invest close to Rs 28,000 a month to accumulate your target corpus. It is suggested you put 80 per cent of your money in corporate bond funds (for safety of capital and good returns) and the remaining in large-cap equity funds (as a growth booster for your portfolio). The portfolio is expected to return close to nine per cent annually.
According to mutual fund rating agency Value Research, corporate bond funds like ICICI Prudential Corporate Bond and Principal Debt Opportunities Corporate have returned over 9.5 per cent in the past year. Large-cap equity funds have returned over 10 per cent in the same period. Majumder has assumed corporate bonds will return eight per cent yearly (net of tax) and a large-cap fund will give 12 per cent a year (net of tax).
| PLANNING FOR A FUTURE | ||||||
| Amount (Rs) | Time (yrs) | Instruments | Debt-Equity ratio | Expected Return (%) | Yearly saving required (Rs) | |
| Child 1 | 2,000,000 | 5 | Corporate bond fund, diversified large-cap equity fund | 80-20 | 8.8 | 3,35,519.39 |
| Child 2 | 2,000,000 | 10 | Corporate bond fund, diversified large-cap equity fund | 40-60 or 30-70 | 11.2 | 1,18,455.93 |
| Child 3 | 2,000,000 | 15 | Corporate bond fund, diversified large-cap equity fund | 20-80 | 11.2 | 57207.85 |
| Child 1 | 5,000,000 | 5 | Corporate bond fund, diversified large-cap equity fund | 80-20 | 8.8 | 8,38,798.48 |
| Child 2 | 5,000,000 | 10 | Corporate bond fund, diversified large-cap equity fund | 40-60 or 30-70 | 11.2 | 2,96,139.84 |
| Child 3 | 5,000,000 | 15 | Corporate bond fund, diversified large-cap equity fund | 20-80 | 11.2 | 1,43,019.63 |
| Child 1 | 10,000,000 | 5 | Corporate bond fund, diversified large-cap equity fund | 80-20 | 8.8 | 16,77,596.96 |
| Child 2 | 10,000,000 | 10 | Corporate bond fund, diversified large-cap equity fund | 40-60 or 30-70 | 11.2 | 5,92,279.67 |
| Child 3 | 10,000,000 | 15 | Corporate bond fund, diversified large-cap equity fund | 20-80 | 11.2 | 2,86,039.25 |
Even from tax perspective, these schemes are good, as income from debt funds gets indexation benefit if invested in for one year or more. And, returns from equity schemes are exempt from tax if invested for one year or more.
Corporate bond funds are mutual fund schemes that invest in debentures issued by private sector companies. These are less risky than equity funds, on the back of the corporate guarantee. However, a guarantee is only as good as the financial strength of the guarantor or the company.
You can choose a debt fund investing in government securities as well in place of a corporate bond fund. However, experts say corporate bonds are safer than government securities because the latter is issued for 30-40 years at a time, which means you get locked in at a rate, say 10 per cent, for those many years. In the meantime if the interest rate goes up further, you lose out on it. In comparison, corporate bonds have a shorter lock-in, that is, they are issued for six-seven years and you can take better advantage of the interest rate cycle.
In comparison, saving for the other two children will be easier, as the time horizons are longer. As mentioned earlier, you will need to make an investment of Rs 10,000 monthly to build a corpus of Rs 20 lakh. You are suggested to invest 70-80 per cent of the amount in large-cap funds and the rest in corporate bonds if your risk-taking ability is high. The portfolio is expected to return 11.2 per cent. Risk-averse investors could invest 60 per cent of the investible amount in equity and the remaining amount in debt.
Lastly, if the time horizon is 15 years, the investment amount is less than half at Rs 4,500 a month. The debt equity ratio suggested is 20:80, with returns expected at 11.2 per cent.
It is often seen that parents, sometimes even grandparents, buy insurance-cum-investment schemes to save for their child’s future. It is advised you avoid doing so. These schemes are very expensive compared to mutual funds, in spite of the insurance regulator capping charges on unit-linked plans and the traditional ones are not very transparent and low yielding. These schemes charges a huge premium but the fund value on maturity is mostly not be as big as promised at the time of sale. If you own one such scheme, financial planners suggest you withdraw if you are out of the lock-in period.
