Future of our Children:
The future of our children is probably the biggest concern for most parents. Many parents start saving for their children’s education and marriage, soon after the child is born. This is, of course, the right thing to do, because the parents can benefit from power of compounding while the child is growing up.
As far as investment choices for their children are concerned Indian parents are mostly conservative. Public Provident Fund, National Savings Certificate and life insurance endowment plans have traditionally been the preferred investment options for the children’s education and marriage. These investment options continue to be preferred choice of a majority of parents today. While these investment choices offer safety of capital, on the flip side the yield of these investments is quite limited. Cost of living in general and cost of education in particular has been increasing at such a pace in India, that relying on low yield investments may leave parents short of the goals they have set for their children or force them to compromise on other important goals like retirement planning. In this two part series, we will discuss investment choices that will help parents meet the financial goals for their children’s future.
As per market surveys, education cost is growing at a rate of 20 – 25% per annum. PPF and NSC interest rates are currently at 7.8%. PPF returns are tax free, but NSC returns are not. Returns of life insurance endowment plans are tax free, but it is only around 4-6% depending on the tenure of the policy. You can do the math yourself to see how much you will need for the higher education of your young child factoring in inflation and the maturity amount of your investment at your current savings rate or even at an accelerated savings rate.
Simply put, the gap between the cost inflation in education and returns of low risk investment options is just too large. The thought of falling short of our children’s goals is difficult for any parent. Fortunately many young, financially savvy, parents are investing in EQUITY MUTUAL FUNDS which over a horizon of 10 to 15 years, when the children are growing up, can give sufficient returns to beat inflation and with proper planning can help the parents meet the financial goals for their children, without having to compromise on other important life goals.
However, when it comes to equity investment the biggest worry of the average investor is risk, the worry about the safety of your capital. When it concerns the future of our children, can we take risks? There two points that parents need to consider regarding risk of equity investments. Firstly, the yields of low risk investment (e.g. PPF, NSC etc.) falling substantially short of cost inflation, leave you with the risk of not meeting the financial goal for your children. Secondly, we need to understand risk and return in the context of long investment horizon.
Risk and Return in Equity Investing:
Mutual funds are subject to market risks. The net asset value (NAV) of your mutual fund investment goes up or down on a daily basis. This is also known as volatility. But should you worry about daily volatility, if you are a long term investor? Over the last 20 years, the Sensex has given an annualised return of 17.8%, despite through big crash in 2008.
For parents who want to save for their children’s education or marriage, mutual fund is the best investment option. Since children’s education or marriage is a long term financial objective, like retirement planning, it is important to note the following from a financial planning perspective:
Equity as an asset class provides the best returns over a long time horizon. As such equity oriented mutual funds are the best investment options for long term objectives
Investors need to maintain a long term outlook and not be influenced by the short termvolatility of NAVs. Lot of mutual fund investors redeemed their units or discontinued their SIPs, and switched their investments to bank FDs when there was sharp downturn in the markets in 2008 – 2009. If they had continued to remain invested in mutual funds, the net worth of their investments would have been much higher today.
Investors need to have a disciplined approach to investing for children’s education. Systematic Investment Plans (SIPs) ensure that you stay on track with your investments.
Investors should always consider the tax aspect and evaluate investment choices based on post tax returns. Interest in Bank FDs is treated as income and subject to income tax.
Whereas for mutual funds, as long as you are invested, there is no taxation. On redemption, long term (over one year) capital gains for equity funds oriented (more than 65% exposure to equities) are tax exempt. While capital gains from debt oriented funds are subject to taxation, investors can avail of indexation benefit. Over a long period of time with indexation, investors can reduce taxes close to zero. Further, dividends from equity funds are tax free.
Investors should assess their risk profile in making investment choices. Investors who are only two or three years away from their child’s goal should avoid equities. Mutual funds offer lot of investment options for investors with various risk profiles. There are both equity oriented and debt oriented child plans.
Click on the given Link to know Child Plans offered by Mutual Funds.