Do children-oriented MFs make sense?

Investing for a child’s future is one of the biggest goals of every parent. To help achieve this, mutual funds (MFs) offer solution-oriented schemes or hybrid schemes that invest in equity as well as debt markets. 

A children’s fund usually comes with a lock-in period of five years or until the child becomes a major. These products are marketed as suitable for child-specific goals such as educational expenses, relocation, or marriage. These products can help investors protect against market volatility to some extent. 

These funds usually come under the aggressive hybrid category where 65-80% of the money is invested in equity shares and the rest in bonds. Certain schemes are also debt-oriented, while there is also some cash allocation in these schemes depending on the scheme constitution and  market conditions. Some schemes are also filed under the flexi-cap category where most of the funds are in equity. Some fund houses also offer no lock-in option of children-oriented schemes, but to encourage long-term investments, they impose stiff penalties, or exit loads, for early withdrawals from such schemes. This exit load can go up to 4% in certain schemes if money is withdrawn before five years. 

Suresh Sadagopan, managing director and principal officer at Ladder7 Wealth Planners, says these schemes have both pros and cons. “Changes in child plans cannot be made midway because these are long-duration products with lock-in periods and/or exit loads. On the other hand, these products might benefit from client psychology. Since the money is invested in the name of the child, an investor might be reluctant to touch the money. Since these products are no different from other MF schemes, I would suggest other appropriate funds instead,” Sadagopan said. 

On the taxation front, since most of these schemes are equity funds and have a lock-in period of five years, long-term capital gains (holding period of above one year) in excess of ₹1 lakh are taxed at the rate of 10%.  Experts feel that as long as an investor is disciplined and investing for the long term, solution-oriented children’s funds don’t make much sense. Further, these schemes have generally high expense ratios, which investors should keep in mind. 

Prableen Bajpai, founder, FinFix Research & Analytics, also feels that the only factor working in favour of these schemes is the emotional quotient. “However, since these schemes are either managed as an aggressive hybrid and flexi-cap fund, they may or may not be the right fit for the purpose. Thus, investors must check the style of the scheme. Investing in a scheme that is managed like a hybrid fund doesn’t make sense if the investment horizon is around 15 years. Investors would be better off with a regular open-ended equity scheme if the child is quite young,” Bajpai said. In addition, investing in just one scheme for a child’s education would result in concentration risk with low flexibility to exit.  Some international diversification should be added if parents plan to send kids abroad for education. 

For investors with a medium-term horizon, investing in a balanced advantage fund or a large-cap index would be a better strategy, Bajpai suggests.