How to select the best mutual funds for child education plans?
6 min read . Updated: 13 Sep 2022, 11:10 AM IST
Premium- In terms of personal finances, it appears that financing a child's education is the most crucial responsibility that cannot be neglected.
In terms of personal finances, it appears that financing a child's education is the most crucial responsibility that cannot be neglected. When making financial plans for a child's education, a person may aim for greater return investments with reduced risk. In this case, mutual funds are the best investment choice since they have a history of exceeding benchmark indices and inflation in terms of returns. Before investing in a mutual fund, parents should take into account a number of other factors in addition to starting savings as soon as possible, such as the child's age, educational route, investment horizon, capacity for accepting risk, asset allocation, and capital accumulation for children's future goals. Fixed deposits are the standard means for long-term goals, but due to rocketing inflation, the RBI increased the repo rate by 50 basis points at its MPC meeting in August, which caused bank fixed deposit interest rates to increase.
However, the average long-term return is only about 7.5%, which is taxable income, and after retail inflation, as measured by the Consumer Price Index (CPI), surged to 7% in August, the average fixed deposit return is not a worthy deal. The Nifty 50 Index, on the other hand, has returned 13% (CAGR) over the past ten years, with a 10-year rolling return of 17% and 15% CAGR in the last 20 years, demonstrating how the equity market has performed in the long run. Through mutual funds, you may hedge your risk profile and get exposure to the equity markets through systematic investment plans (SIPs). However, there are many different fund types available on the market, so which one should you choose for your child's education? Let's find out.
By commenting on the topic, Abhishek Dev, Co-Founder & CEO of Epsilon Money Mart Pvt Ltd said “There is no simple answer when it comes to saving for your children’s education. There are a lot of factors to consider such as the time frame, the field of specialization (medicine will cost a lot more commerce!) and of course, many parent’s dream – to send their children abroad and have them study there, where currency fluctuations will also play a role."
Which mutual fund category is best for a child’s education?
Equity funds have been divided into many categories, each of which has a particular risk profile, even though all equity and equity-related instruments are vulnerable to market risks. The many well-known categories of equity funds include large-cap funds, midcap funds, small-cap funds, large and midcap funds, and multi-cap funds. Solution-oriented mutual funds, however, according to Mr Abhishek Dev, are beneficial for children's education. According to SEBI, there are four categories of solution-oriented & other funds: retirement fund, children's fund, index funds/ETFs, and fund of funds (domestic/international). A minimum 5-year lock-in term is mandatory for the Children's Fund category, or until the child reaches the age of majority, whichever comes first.
Owing to a better investment strategy for a child’s education, Mr Abhishek Dev said “The easy way to do it is to simply invest in Solution-Oriented Mutual Funds which focus on Children’s Education. You have some of the largest AMCs offering these types of funds from Aditya Birla to ICICI, HDFC, SBI, Tata, UTI etc. Usually, with a judicious mix of equity and debt in their underlying portfolios, these funds have given an average return of 14.9% since inception (category average). Usually, these funds also have a minimum lock-in period (i.e. 5 years) and can be extended till the child becomes an adult. Tax benefits may be available for such funds."
Pros and cons of Solution-Oriented Mutual Funds
Only those who are on a route to achieving long-term goals by incorporating the lock-in period may use solution-oriented mutual funds. As the fund manager is allowed to invest and have exposure to both equity and debt instruments where the allocation proportion may change based on the age group of investors, resulting in having a primary objective of wealth creation and stability in the long run. Some Solution Oriented Mutual Funds provide tax benefits, due to the lock-in period of 5 years one can claim tax deductions up to ₹1.5 lakh per annum under section 80C. But before committing to an investment, one should carefully investigate the fund's performance, the history of the fund house, and the associated charges, such as the entry and exit load, expense ratio and so on.
Abhishek Dev, Co-Founder & CEO of Epsilon Money Mart Pvt Ltd said “The limitation for this approach is you are completely dependent on the calls of the fund manager and are at risk of the fund not performing that well when you need to redeem – the other issue is the lock-in, in case some money is needed as an emergency then it may not be possible to redeem before the 5-year period. The other way to do it is to calculate the estimated time period and the amount you think you will need and create a dedicated portfolio towards this goal of children’s education. There are enough and more calculators online that will help you determine the final amount you need to invest based on the time period (please be mindful of inflation). Here you will, though your wealth manager, be in better charge of your portfolio. However, you will have to work on rebalancing your portfolio – making it more debt oriented as the goal gets closer."
Which type of investors should invest in Solution-Oriented Mutual Funds?
Investors that are exclusively interested in achieving particular long-term financial goals are suited since the fund comprises primary objectives. Due to its short-term volatility, equity funds may not be deemed appropriate for achieving short-term financial objectives and hence are not recommended for short-term investors. Owing to the lock-in period, investors cannot switch to other funds and even cannot make premature withdrawals in the event of an unanticipated emergency, increasing the fund's risk even if a scheme performs worse than its benchmark index.
Abhishek Dev said “Risk tolerance is completely different for each individual and depends on the investor. Though if the investment horizon is more than 10 years then one can look at higher exposure to equities as an asset class since equities tend to give better returns over the long term and can help achieve one’s goal that much better."
How to start investing in Solution-Oriented Mutual Funds?
Financial advisors highly recommend the SIP route when it comes to mutual funds because it enables you to experience the power of compounding, low initial investment starting at ₹500 per month, rupee cost averaging at the different market scenarios, higher returns through SIP when compared to traditional fixed deposits/small savings schemes, and flexible investment strategy.
Abhishek Dev said “Believe that SIP is a good way to invest – whether for children’s education or any other long-term goal. The discipline of investing is in-built into this approach and also the power of compounding and averaging help you reach the goal better since the returns are also able to generate returns on them! Given that the cost of education is skyrocketing, most of us may not have the privilege of a lump sum investment. Also, since the time period for this goal could be 5 years plus, SIP could be a good way to go when it comes to planning for your children’s education."
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.
