5 steps to build your child's education corpus

As parents, it is but human to have expectations about our child's future -- whether it is fulfilling their trivial wishes, education or marriage. In fact, we Indians so strongly believe in the adage 'education is insurance', that we are willing to cut down expenses on shopping and outings to save for our child's education.

However, given the low level of financial awareness in our country and the well-known mis-selling of financial products, it wouldn't be surprising if many of us fall short of funds. This is where we will encounter our next nightmare.

If we dig into our retirement savings (as many of us do), we will dent a blow into our retirement corpus, ruining our standard of living during post-retirement, and possibly end up becoming a financial burden on our children.

There were days when investments in Public Provident Fund (PPF), Kisan Vikas Patra (KVP), National Savings Certificate (NSC) and bank fixed deposits earned a sound rate of return. So even with minimal planning, parents could manage to make ends meet as far as financial planning for their children's future needs was concerned. Today, the rate of return on these traditional products has gradually come down over the years, and not to mention, with inflation fast catching up.

Planning early for your kid's future has become all the more relevant today if you want to give wings to their dreams. Here's why.

The author is a certified financial planner.

Why plan early?

The primary need to plan and invest for your child's future largely emanates from two factors:

1) Inflation and
2) Inflation.

In fact, inflation is the principal factor necessitating the entire financial planning process.

In simple words, inflation means a general increase in prices of goods and services. For instance, today a family has to shell out up to 3X more to acquire the same goods or services one received 10-15 years earlier.

In the last one decade, the cost of education, especially, quality education and foreign education has moved up substantially. The cost of primary education in quality international schools is anywhere between Rs 1 lakh to Rs 2 lakh per annum, not to mention, the skyrocketing costs at the graduate and PG levels.

Adding to that the fact is that the child may pursue arts or medicine or commerce or engineering, which is not clear during their schooling years. So, how much amount has to be set aside for their education needs becomes a very tricky question.

Let's understand this better by way of an example.

Let's say an engineering degree from a leading college would cost around Rs 10 lakh (in today's value) and an MBA degree would cost around Rs 15 lakh (in today's value).

If your child is aged 5 years today, then, by the time she/he is 18 years (that is, in 13 years' time), the same engineering degree would cost you Rs 21.3 lakh and an MBA degree would cost around Rs 32 lakh: over two-fold increase in 13 years assuming an inflation rate of 6 per cent per annum!

The table below is quite an eye-opener. For parents who don't have time on their side, achieving an adequate education corpus can become a daunting task.

In such circumstances, they may be forced to take a higher degree of risk (not attuned with their risk appetite) and in most cases, compromise on quality of education itself.

If you don't 'inflation-adjust' your child's education savings, it can make a real dent to your future plans. So it is imperative that we make elaborate plans to meet it head on.

The key to planning is to plan as early as possible. The earlier you plan, the lower the amount you need to put aside, and vice versa. Start early and give your investments sufficient time to grow.

InvestmentYogi lists out a few effective steps to build a suitable education corpus for your bundle of joy.

Step 1

Insure yourself first. Yes, you heard us right. As a parent, you need to shield yourself before you start investing for your child. Ensure you have adequate health and life insurance coverage, so that your family's needs are not compromised in your absence.

In case you don't have one, you should consider taking one immediately. Those who have already bought insurance, ensure you are covered adequately. Less insurance is akin to no insurance.

You may use insurance calculators to find out your insurance needs:

Insurance calculator (http://www.investmentyogi.com/FinancialCalculators.aspx?a=8): Expense protection method

Insurance calculator (http://www.investmentyogi.com/FinancialCalculators.aspx?a=9): Human Life Value method

Step 2

Open and maintain a separate 'savings' bank account' for your child's investments and other short-term requirements. From this account, you may begin your child's investment plans.

With so many goals and different investments made to reach each one of them, it's easy for things to get jumbled. Therefore, it is important to keep your child's investments in a separate account even if you are investing in the same mutual fund scheme or investment, for another goal. This way, you won't accidentally end up using your kid's investments. Tracking your kid's corpus becomes easier by following this step.

Step 3

Project now the corpus you will require in the future.

The next step should be to have a unique plan in place for each objective and allocate resources accordingly.

Projecting for the long-term is never accurate: Your child might end up doing a course requiring lesser/more money than expected, investment returns could be different from the ones assumed, or parents might not invest regularly the required investment every year.

But nonetheless, if you refuse to make a plan and adhere to it, there's a high probability that you may not achieve your financial goals, unless you get lucky!

You could project your target amount first (inflation-adjusted, that is) and then work backwards to ascertain how much money you need to put aside every month.

Example: At an inflation rate of 6 per cent per annum, an engineering degree that costs Rs 10 lakh (in today's value) will cost around Rs 21 lakh after 13 years. So, at a growth rate of 15 per cent per annum you need to put aside Rs 4,420 per month for 13 years to reach that goal.

Similarly, a two-year, full-time MBA course that costs around Rs 15 lakh (in today's value), would cost around Rs 32 lakh after 13 years' time. Again assuming an interest rate of 15 per cent per annum, you will need to put aside Rs 6,730 per month for 13 years to reach the target amount.

Step 4: Asset allocation

You may choose from a basket of products to build your child's education corpus. These include both assured return schemes and market-linked instruments. However, your risk appetite and investment objective should ideally dictate the investments made by you.

You have to also consider the time horizon.

Following is the list of assets (listed priority wise) one can choose from:

Equity:

1. Mutual funds

Equity Index funds; Exchange Traded Funds (ETFs);

Equity-linked saving schemes (ELSS);

Large-cap equity diversified mutual funds;

2. Shares/Stocks:

If you are a risk taker, you may start-off by investing in blue-chip, FMCG and pharmaceutical stocks.

Note of caution: Buy only after thorough research. In case you are new to stock market (or you do not have exposure in this area), you are better off investing through mutual funds as they offer better diversification and expertise.

3. Debt

1. Post-Office Saving Schemes

Although, mostly all schemes of the post-office offer an interest rate around 8 per cent per annum, choose the scheme(s) which match your time horizon and offer tax benefits too.

For example, in case your child is aged 5 and needs money for his MBA (which is after 15 years), a PPF scheme is ideal. But in case you require money in mid-term (say in 6-7 years) for his high school admission, you may consider investing in National Savings Certificate (NSC).

2. Bank term deposits

3. Zero coupon long term bonds:

These bonds can be a useful bet for risk-averse investors requiring  funds over the long-term (+ 5 years).

Other investments

1. Gold/Gold ETFs: It is a good hedge against inflation. However, ensure maximum of 5-10 per cent of portfolio.

2. Real estate: Although it gives good capital appreciation, it is an illiquid asset. Maximum exposure should be not more than 20 to 25 per cent of portfolio.

Note: For real estate investment, residential house property can be a good bet compared to commercial property and empty plots.

3. Insurance: Life insurance and health insurance on self and/spouse with children as the nominees.

An ideal portfolio would comprise of instruments from all the above categories in varying proportions: a judicious mix of debt and equity so that you have both safety and returns.

Note:

Nowadays, some fund houses are offering dedicated child plans (children's ULIPs and children specific mutual funds). However, one needn't have to buy everything that's offered in the market in the name of children's specific investments. A right mix of the above products will do the job and will cost you much cheaper. Parents are advised to read the product prospectus carefully before investing.

For example, a 'children specific mutual fund' is not quite different from the normal mutual fund schemes available today. You could as well invest in top-rated equity diversified schemes and index ETFs. Few best performing diversified equity schemes you can look at are HDFC Top 200 and DSP BlackRock Top 100 Equity. In Index ETF category, you can look at Nifty BsES Index ETF.

Whichever scheme you invest, a disciplined approach holds the key to financial freedom.

You could accumulate education corpus in safe investment options, such as, PPF, bank term deposits, etc. However, this cannot be the only way to build the child's education corpus. A 100 per cent debt portfolio is definitely high on the safety meter but the growth of the corpus will be abysmal.

Through the years, parents have been making the mistake of consciously choosing debt over equity because they think it is safe. On the contrary, long-term returns from debt are abysmal and most of it gets eroded by inflation.

Equity (in any form) should comprise a considerable portion of one's long-term education portfolio. Historically, equity as an asset class has been giving an average return of around 12 to 15 per cent per annum and hence is required to counter the ill-effects of tax and inflation.

A lot of people get unnerved by the short-term fluctuations. But the risk of losing money comes down when held for a long period (+ 10 years), and that is the reason why they make excellent savings vehicles for building an education corpus.

For many salaried employees, making a lump sum investment is not possible. Added to that, the idea of accumulating huge sums of money seems like an overwhelming task.

So do consider systematic investment plan (SIP). A SIP offers a lot of advantages, the main being the ease of investment. SIP can be made for equity mutual funds through the ease of internet banking (ECS debit facility) and therefore, can happen smoothly every month, without feeling a pinch in your pocket.

Once you shortlist investments, it's time to invest. You could either invest in your child's name or make investments in your own name. There is no rule of thumb in this matter. But make sure that the funds are used for your child's needs only.

For those who have started late or finding it difficult to manage your child's investments due to other obligations do not fret. There is the comfort of an 'education loan' for higher studies. Also, considering the rising cost of higher education over the years, many would find it hard to fund the entire course expenses through their own resources.

In such circumstances, education loans provide an alternative. An education loan typically covers education expenses such as fees payable to college, purchase of books/equipment/instruments, examination, library, laboratory fees etc. However, the coverage could vary across lending institutions.

However, banks have always maintained lower approval ratio on education loans. So it is prudent to maintain a respectable credit history, and accumulate as much as possible through one's own resources.

Step 5:

Lastly, keep evaluating the performance of the various investments (at regular periods like a 3-year or a 5-year period) to find out if they are shaping up as expected, and when the goal is a couple of years away - move the assets to safe debt instruments, so that any falls in the market/economy do not erode the gains you made so far.

Conclusion: The ideal way to build an adequate corpus for your child's future is to go step-by-step. The earlier you start the better. A combination of correct investment advice, proper investments and sufficient time can help you achieve all your goals.