Give Them A Head Start
Strategies to turbo-charge your investments
Fixed Income
PPF: Open an account for your kid in the first year, extend the account after tenure ends
NSC and FD: De-risk portfolio with them, create income ladders to meet regular higher education expenses
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Mutual Funds
Begin with index funds
Combine with tax-savings: Use well-performing ELSS schemes to combine tax-savings with investing for kids.
Stick to large-cap focused equity funds
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Child Ulips
Go for growth: Opt for maximum equity exposure
Ensure waiver of premium option in child plans
Compare post-cost returns and fund performance
Switch to lower risk option near the end of the term
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Stocks
Begin with large-caps: Defensive pharma and FMCG picks for lower risk appetite and capital goods, engineering, construction, power and telecom for growth-seekers
Get defensive with time: Stick to large-caps
Regularly review portfolio
Time your de-risking: Start at least 3 years before you need your money
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Real Estate
Invest in your or spouse’s name
Limit exposure: Don’t exceed 25 per cent of portfolio’s value.
Begin with residential property, lowest risk option
Next: commercial property. Involves higher risk, higher return.
Plots: Tread with caution
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Your son wants to be a computer whiz one day, a rock star on the other and an actor on the third, while you secretly wish that he becomes the cricketer you always wanted to be. Whatever be your kid’s ambition or your dreams for him, reaching there will require money; lots of it. From tuitions, hobbies to professional undergraduate and graduate studies, everything is getting expensive by the day, most often outsprinting the general inflation rate. That’s not to forget costs for marriage, which will be no less a financial responsibility. Take a look at how the numbers stack up.
Assume that your child is five years old now and will pursue an engineering degree at 18. The cost of engineering today is, say, 7 lakh and the rate of inflation is conservatively placed at 7 per cent per annum. Since inflation of educational costs outpaces inflation, you will need to assume a 10 per cent inflation figure here. Therefore, the inflation-adjusted corpus after 13 years would be around Rs 24,16,589. The amount is more than 3.45 times of today’s cost. With diverse requirements—such as those of acquisition of home, retirement, healthcare provisions and nearer-term goals, like foreign vacations and upgrading your car—all competing for your funds, how does one make sure that adequate provisions are made for the future of children? The answer lies in a three-step approach.
Step 1 Find The Target Amount
Before you save and invest, you first need to know how much your child will need. This gives you a target to shoot at. Bypassing this essential prerequisite often results in us not being able to make an important distinction on what will work for us and what won’t.
Step 2 Determine Your Regular Investment Amount
This follows from the total amount you have determined. Suppose your child is one year old and will pursue an MBA course at the age of 22. The MBA cost today at Rs 8 lakh will become Rs 59,20,200 at the time your child turns 21. To accumulate the corpus of Rs 59,20,200, you need to invest only Rs 5,730 in equity instruments which will fetch you 12 per cent return. On the other hand, assume that your child is 11 years old and will pursue the same MBA course, which today costs you Rs 8 lakh. The inflated cost of MBA after 11 years, when your child will go for the same course, would be around Rs 22,82,493. To accumulate this corpus, you need to invest Rs 8,738 in the same instruments which will give you a 12 per cent return. If you were to invest Rs 3,200 only, you will have to get 25.60 per cent returns for which you need to get lucky after investing in very high-risk investments, given that stocks historically have given return of around 17 per cent over a period of 25 years.
Never too early to Plan
*Assuming inflation rate of 7 per cent 1 :Average fee of rated institute in India. It includes college fee and living expenses 2 : Average cost of wedding in India. It could be less in some cases or more Returns calculated on CAGR basis. Assuming investors invest in the beginning of every month.
Step 3 Fire!
Once you have got a sense of what to do, adopt a methodical approach towards reaching your goal.
Get the risk cover pad. Before you invest, ensure that you have adequate insurance cover for life and health. Otherwise, your accumulated assets will remain vulnerable to distress sales in the event of your untimely absence or other mishaps.
Create a parking slot for your savings. This could be your salary account or children’s savings account where the savings for your children will come or be pooled. From such an account, you can direct your savings towards various investments.
Invest in various assets across risk levels. No asset class can continuously do well. Therefore, you need to have a finger in different asset pies in right amounts so that your investment keeps growing. This means you need to have a mix of assets beginning from Public Provident Fund (PPF), index funds or exchange-traded funds, large-cap focused diversified equity funds, large-cap blue-chip stocks, gold exchange-traded funds (ETFs), unit-linked insurance plans (Ulips) and even real estate.
Take risk initially, derisk at the end. As with retirement, investing for your kids’ future, if started early, allows you to invest in investment options such as diversified equity funds and large-cap blue-chip stocks in the beginning. These give you the gains from equity investing over a period of time. But as one is 2-3 years away from the expected year of using the funds, the money in higher risk assets should be slowly moved away to lower risk options such as short-term debt funds, fixed deposits and so on. In Ulips, especially kids’ Ulips, you can use the switching option to migrate your money to a much lower-risk option.
Investment Strategies
Your child can have his favourite dish anywhere, but what’s served at home might always get top billing. Despite the same ingredients, your mix at home makes the crucial difference. Combining various asset classes is also a similar exercise. You need to adjust your asset mix according to your needs. This can be done well if you keep certain strategies in mind.
Fixed Income Strategy
PPF first. This 15-year post office option, currently providing 8 per cent per annum, is a great bet with contribution, interest and final amount being tax-free. What’s more, you can avail tax benefits of up to Rs 70,000 (the maximum annual contribution) for your and your kid’s PPF account. The money here can’t be attached and it gives you a secure source of funds, should you find yourself in a long downturn cycle of 3-4 years near the time you need the money. Open a PPF account for your kid in the first year of the child. After the 15-year period is over, you can extend it for periods of five years, as you deem necessary.
Tulika Trivedi, 10
This is what she drew when we asked her what she wanted to become. She sees herself as an intrepid traveller, living in Goa, being a fashion designer and dance choreographer
NSC for income ladders. National Savings Certificate (NSC) with a term of six years is a great option towards the end of your accumulation period. At that point, you need to derisk and also anticipate future regular cash requirements. If your child needs to pay regular hostel fees when he joins college at age 18, you could start derisking his portfolio and buy an NSC every month. This will ensure cash flow of one NSC maturing every month.
Fixed deposit. Fixed deposits are also wonderful options to derisk and create income ladders, or just a secure parking slot. If you are in the highest tax slab, you can even consider parking a portion of the money in short-term debt funds as they would be more tax efficient, but will come with higher risk.
Other options. You can use recurring deposits (RDs), especially those for kids, if you are a small saver and have low risk appetite. They can also be used as a parking slot for people who can only save small amounts or have irregular income flows, such as a salesperson. They can use accumulations in RDs to service regular obligations such as premium payments. If you have money over and above PPF, you can take a shot at corporate bonds—for the short term and with limited exposure—due to their higher risk. While it’s good to have some variety in fixed income options for your kid, it needs to be done in the later half of the accumulation stage.
Mutual Fund Strategy
The cornerstone of the mutual fund (MF) strategy for you is to get the benefit of growth investing in stocks without spending large amounts of money or risk, besides getting the advantage of a fund manager’s expertise.
Index fund for beginners…. If you haven’t ever invested in high-risk investments, index funds is a good bet as they mirror the market with fund investing in stocks constituting the market index in the same proportion as the weights of the index.
…or even ELSS. One can invest in a top tax-saving equity-linked savings schemes (ELSS) and the investment can be earmarked for the kid’s future, helping you to save taxes as well as prepare for his future.
Stick to large-cap focused diversified equity funds. A large-cap fund is actively managed by the fund manager, unlike index funds, and invests in well-established firms. Therefore, they are less volatile compared to other mid-cap and sector-specific funds. Choose funds such as DSP BlackRock Top 100, HDFC Top 200 and other funds in the current OLM-50, our recommended funds. If you are comfortable with risk taking, you can even have a small exposure in mid-cap or thematic funds.
No-no to children’s MF schemes. Most such funds are invested in debt, which defeats the basic purpose of growth investing. Worse, they are not doing too well. For example, HDFC Children Gift has returned only 23.99 per cent and Tata Young Citizen Fund 44.33 per cent as against 76.02 per cent average return of diversified equity funds in last one year. “It’s better to invest in index fund or else diversified equity funds with proven track record,’’ feels Veer Sardesai, a Pune-based financial planner.
Ulip Strategy
We will go through this in detail in a subsequent article, but at the moment, it will suffice to say that when you are buying unit-linked plans that provide life insurance and you have investments like mutual funds, you need to ensure that you have adequate life cover from the policy or from other sources. Focus on the highest equity exposure variant and pick the policy that gives the highest projected fund value post costs at the rates of 6 per cent and 10 per cent—the rates of return mandated for sales illustration by the Insurance Regulatory and Development Authority (Irda). If it is a kid’s plan, you need to ensure that the policy continues to be in force even in the event of your untimely demise.
Stocks Strategy
Get into direct investing of stocks if you have the appetite for it. It can boost the returns of your kid’s portfolio over the long term. Remember, it is not just the returns. There is also the risk of losing out on returns and a small or large part of the principal too. Here are some pointers to buying stocks for your kid’s future:
Large-cap for beginners. You could consider defensive stocks from sectors such as pharmaceuticals and FMCG, but buy them after proper research. Take the help of common thumb rules, such as buying stocks that give return on equity of over 10 per cent and are not priced over 10-15 times of their earnings. If your kid is less than five years of age and you can take risk, go for growth stocks in sectors such as capital goods, engineering, construction, power and telecom.
Get defensive with time. As your child grows, buy only large caps. The idea is to contain risk.
Regularly review your portfolio. This helps weed out losers and also reduces overexposure stocks when markets shoot up.
De-risk on time. Gradually move away from equities with about three years remaining from the time of use of the money.
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Real Estate Strategy
After having a house for self-occupation, it’s not a bad idea to acquire another. This could be part of the portfolio for your kid’s future and lend diversity to it. A few things need to noted:
Invest in your or spouse’s name. This gives you the flexibility to use it for other purposes, if the need arises. Needs of your child might change and you can always gift it later to him.
Limit exposure. Real estate should be between 20-25 per cent of the portfolio: it has high transaction costs and lacks liquidity.
Residential property for beginners. It is considered to be the least risky of all real estate investments because of the high mismatch between demand and supply. If you have plans to rent it out, look at the area’s rental value and its trends over the years. If you are borrowing to invest, ensure that the rental covers your monthly instalments, either partly or wholly. Factor in unlimited tax benefits on interest repayments for the second house.
Commercial property for higher returns. They are considered to have a higher rate of return than residential properties, but you still need to study rental trends in the area first. A dip in rentals is a big risk. It’s best to choose small-to-medium-size properties. Investors can also consider commercial properties in semi-residential areas. With the growth of entrepreneurs, the need for commercial spaces in semi-residential areas is on the rise.
Plots. After having a residential property and a commercial property in your portfolio, you can consider plots. Plots are popular investments, but are not very easy to manage and carry several risks. However, returns here are the highest. The main problems include encroachment and change in taxes. It is best not to consider plots if you cannot actively manage them.
Gold Strategy
If a cake needs a cherry topping, a portfolio needs some exposure to gold to give it a good balance. Outlook Money has advocated 5-10 per cent of any portfolio being in gold. You can buy a pure gold coin or a bar on your child’s birthday every year. The other option is to buy paper gold or gold exchange-traded funds.
A super portfolio earmarked for your kid’s future is not a guarantee for his success, but it increases the probability that he will never be left behind for lack of funds. Instead of fighting the odds, as you or your parents might have done, this will give an edge that might turn out to be the winning one in the long run.