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Your children need financial attention, too

Your children need financial attention, too
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First Published: Mon, Feb 07 2011. 09 38 PM IST
Updated: Mon, Feb 07 2011. 09 38 PM IST
Thrilling as it is to see your child grow, parenthood also comes with a number of responsibilities. You have to plan out her education, marriage, perhaps even her career. It costs money, and it is important that you plan in advance—so that your child’s future security does not put your own retirement funding at risk. Sound investments should be backed by adequate insurance to take care of unexpected events. Mint Money gives you a guide to plan your child’s future using insurance and investments efficiently.
Opt for equities
Given the rising cost of almost everything you buy these days, including escalating school and college fees that pinch harder if you have more than one kid in the household, the biggest advantage that you have on your side is time. Assuming that your child is just born, you have at least 18 years before she needs money for higher education. Add another three years for postgraduate education. With 18-21 years ahead, you can do wonders if you tap the equity market. We suggest you take the mutual fund (MF) route since it’s tricky to navigate the stock markets on your own. Besides, with as little as Rs5,000 a month that you put aside in an equity fund, you can enjoy diversification across multiple stocks. Consider this: if you had put Rs5,000 every month in Franklin India Bluechip Fund starting 10 years ago, the corpus today would have been Rs24.76 lakh, a return of 26.81%. A similar investment in HDFC Equity would have yielded Rs32.54 lakh, a return of 31.89%. “If the goal is so far away, then equities are the best vehicle,” says Anil Rego, chief executive officer, Right Horizons, a Bangalore-based financial planning firm. “No other vehicle would be able to match the risk-adjusted returns that equities give over a long period.”
Fix a goal
The best way to plan for your child’s future is to fix a goal. For instance, your child may want to study engineering. An engineering course today costs about Rs6 lakh. You have 17 years to go before you need the money. Assuming an average inflation of 6%, an engineering course would cost Rs16.39 lakh after 17 years. You can check online or use an Excel sheet to ascertain how much money you need to invest every month in a systematic investment plan (SIP), given that the equity market grows at an assumed rate of, say, 15% on average every year. To reach this goal, you need to invest about Rs2,000 per month. Take another example. A two-year, full-time postgraduate diploma in business management at the India Institute of Management, Ahmedabad, the country’s most prestigious business school, costs Rs13.70 lakh. At the assumed inflation, this course might cost Rs46.57 lakh after 21 years. Assuming equity markets were to grow at 15% compounded annualized growth rate, you would need to set aside about Rs3,000 every month. “Instead of putting away money blindly, fixing a goal and then calculating how much money you need to invest is a more systematic way to plan for your child. The chances that you will go off the target get reduced to a very large extent,” says Kapil Mokashi, assistant manager-equity advisory, Sharekhan Ltd.
Which funds to buy
If you plan for a goal that is more than 15 years away, it’s important that your investments also last that long. In other words, fund houses with pedigree and those that come with a long-term track record are important. Schemes that come with around a five-year track record are a must. You can choose a mix of index funds (passively managed) and large-cap-oriented diversified equity funds, though many planners recommend the latter since they are actively managed. “As against the Western countries where index funds have outperformed actively managed funds, in India we have seen many actively managed fund outperform index funds. This works well too since you are planning 15 years ahead,” says G.K. Balaji, head-investing and wealth advisory, Way2Wealth Broker Pvt. Ltd.
Another option is a well-performing balanced fund. Rego suggests that since education and marriage requirements are time-bound (once the goal arrives, they can’t be postponed) unlike retirement planning that is a continuous requirement (you require a monthly income), parents shouldn’t take too much risk with the child’s portfolio. “Avoid sectoral funds for the same reason,” he adds.
Some financial planners such as Mokashi suggest that mid-cap funds should be added too, and with good reason. In the past 10 years, for instance, pure large-cap funds have returned 17% compounded annualized. Those schemes that invest marginally in mid-cap companies have returned 19% while plain-vanilla mid-cap funds have returned 22% in the past 10 years. You can choose from the Mint50 list of curated funds, a sample of which is given in the graph above.
In whose name
It’s preferable to keep the investments in your own name and put your child’s name as a nominee. If you invest in your child’s name and put your name as the guardian, your MF investment will get blocked once your child turns 18. “Not even 1% of the investing population seems to be aware of this rule. They invest in their child’s name and after the child turns 18, they lose control over the funds as the child becomes the first owner of the money,” says a senior sales executive of a foreign MF house who can’t be named on account of his fund house’s compliance issues. If the investments are in your name, you can gradually withdraw money as and when required and continue with your monthly contributions till, say, the time your child starts to earn.
SIP it up
As against a lump sum amount, it bodes well if you enroll for an SIP. Increase your SIP amount as and when, say, you get an increment in your salary. While fund houses such as ICICI Prudential Asset Management Co. Ltd and HDFC Asset Management Co. Ltd allow you to increase SIP amounts in your existing SIPs, most other fund houses mandate you to start a fresh SIP.
Closer to goal, switch to debt
Well managed funds do not warrant constant tracking, but it pays to be alert as you approach your goals. Assume you started your SIP investment of Rs5,000 every month in HDFC Equity Fund on 1 January 2001 and you required your money in around, say, June 2009. If you had stayed invested till January 2009 and then withdrawn after the markets would have hit rock-bottom, you would have made about 21% returns, or Rs11.67 lakh. On the contrary, if you had been a bit watchful and withdrawn when markets started to fall (say in May 2008), you would have ended up with Rs18.78 lakh, or a return of 38%. It is a good idea to begin switching money from equity to safer debt three-five years before your goal is reached.
Public Provident Fund
You can also open a Public Provident Fund (PPF) account in the name of your minor and there is a compelling case to do so. Other than your Employees’ Provident Fund (EPF)—which we recommend for retirement planning—PPF is the only long-term debt vehicle that offers a risk-free, tax-free rate of 8% per annum. And assuming long-term inflation tends to be 6%, the return from PPF also keeps your money ahead of inflation. Since investing for your child is a goal-based investment, you need to invest in PPF as early as possible. To illustrate, an MBA course that costs Rs6 lakh today will cost Rs19.24 lakh 20 years from now, assuming 6% inflation. If you start now, you will be investing about Rs42,050 every year. But if you start only when your child is five years old and joins school, you will have to invest more than Rs70,000 each year. The maximum limit in a PPF is Rs70,000.
How to open a PPF account: You can open a PPF account in your name and in the name of each of your children individually. However, you cannot exceed an overall investment limit of Rs70,000. However, recently many banks have begun refusing opening a PPF account for children. If your bank does so too, you can either change the branch, approach a post office or simply bump up your investment in your account. “An individual can open an account in the name of his child but most banks these days pose a challenge as they have begun to refuse,” says Amar Pandit, a Mumbai-based financial planner. “In this case you need to bump up your investment in your account but will also have to cultivate the discipline of using the funds only for your kids.”
PPF works like an annual or a monthly SIP. You need to invest some amount in the account every year (up to 12 times a year). PPF has a lifespan of 15 years but you have the option to increase the tenor in blocks of five years. The option of partial withdrawal is available from the seventh fiscal year. Investment can only be made in multiples of Rs500. Investments in PPF also give tax deduction benefits under section 80C. The proceeds are tax-free.
Life: Your child is dependant on you for his needs and therefore you need to have adequate life cover. Buy a term plan and review your life insurance cover periodically. While we like term plans, one can look at unit-linked insurance plans (Ulips) for children as they are tailor-made. A typical child Ulip is a type II plan that offer the sum assured as well as the maturity corpus to the beneficiary. In a child Ulip, if the parents die during the term of the policy the beneficiary or the child gets the sum assured. The plan also has an inbuilt waiver of premium rider which means that all the future premiums are paid for and on maturity, typically when the child is gearing up for college, the maturity corpus is paid.
You could look at a child Ulip but make sure it is not expensive. So if the costs bring down your gross yield by more than a percentage point, your buy is expensive. Also keep in mind that a Ulip has a short-term disadvantage and works only over the long term. Buy a policy when your child is very young.
Health: To battle rising medical costs, you need a health cover. And since the danger of a medical emergency looms over all age groups, you need to cover your children too. Health insurance can be had as early as when an individual is three months old. Insurers typically insure a child as a dependant. This can happen either by an add-on cover to the parent’s individual policy by paying an extra premium or by adding the child under a floater plan. Under the floater plan, the cover is the same for all the members of a family. If one member makes a claim, the sum insured is reduced on the entire family by the amount he claims.
A few insurers, such as Apollo Munich Health Co. Ltd and Max Bupa Health Insurance Co. Ltd, also cover the newborn along with the maternity benefits they offer, but this comes at a cost. Says Deepak Mendiratta, managing director, Health and Insurance Integrated, a health insurance consulting firm: “Individual policies that cover new born from day one cover them along with maternity benefits. These maternity benefits come after a waiting period of at least two years or more. And even in these policies, congenital ailments, which are critical in nature, are not covered. Also these policies are relatively expensive since these policies factor in the cost of maternity benefits.”
But if you have a group health insurance policy, your child could be covered from Day 1.
What should you do
Start planning for your kid right away. Every year of investments lost will only add to your burden. Assume in the above example of an engineering course, you are five years late and start your SIP after your child turns five. In this case, you will then need to save a little over Rs3,000 every month, up from Rs2,000 if you start when your child is born. The same goes for your PPF too. Your bundle of joy deserves your best, so go treat him.
Graphic by Yogesh Kumar/Mint
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First Published: Mon, Feb 07 2011. 09 38 PM IST