Personal finance tip: Save early to inflation-proof your child’s higher education
Their child’s education is a priority for Indians. No one wants to compromise on the quality of education given to their daughter or son. The rising cost of education makes many worry about the issue and worse fund-crunch make many give up higher education. Here is how to fund your child’s education.
Set the goal right
The biggest enemy of the investor – inflation, stands between you and your child’s education. Inflation rate is higher in education costs, especially for higher education at premier institutions in India and overseas. If you want to educate your daughter abroad, be prepared to shell out more as you have to account for currency movements. “It is better to account for future value taking into account 10 percent inflation,” says Tarun Birani, founder and director of TBNG Capital Advisors.
For example, if a course today costs Rs 20 lakh, then at 10 percent inflation it will cost you Rs 83.55 lakh in 15 years.
Your goal, thus, should be defined accordingly. You should also know when do you need money and the cash outflows. You may need not to pay the entire course fee at one go. A three-year course may, typically, have three to six large cash outflows towards fees and other expenses. The timelines matter as you can accordingly make a plan to reach your financial goal. Sometimes due to longevity of course, the corpus needs are so large that if you assume the timelines wrong, the investment plan may see large variations.
Earlier you start better off you are
If you want to buy a car and haven’t accumulated enough money, you may settle for a lower variant or you may want to buy it a year later. However, you can’t postpone your daughter’s education. In such circumstances, it is better to start early so that you can manage it better. “If you start early you benefit from magic of compounding. Long time frame also lets you invest in a risky but rewarding asset class such as equity,” says Jitendra PS Solanki.
For example, if you want to accumulate Rs 83.55 lakh (target sum in the above example) in 13 years, at 12 percent rate of interest you have to invest Rs 23,568 per month. Here we are assuming that the investor wants to play conservative and want to raise money at least two years ahead of schedule.
If you are forced to accumulate same amount at same rate of interest in 10 years, then you have to invest Rs 37,645 per month. Starting late by three years make you increase your monthly contribution by almost 60 percent.
A longer time frame also gives you more elbow room to tide over tough times. There are times when one faces medical emergencies or job loss. In such circumstances, the investments may take back seat. Though one should have emergency fund that should pay for such times, one may not have perfect solutions to all problems. And hence more the time frame in hand better it is.
This could be the tough choice for many individuals. When the markets start rallying greed sets in and when they fall the fear takes over. The volatility associated with equity and equity mutual funds cannot be done away with. Hence it is imperative to keep a track of your investments. “Most of these investments made to fund your child’ education are of buy and hold nature. It makes sense to keep reviewing them from time to time,” says Birani.
In a good year you may also want to shift some money away from equity mutual funds and such other risky products to a less risky bond fund. Thus you take home some money and not exposed to the vagaries of the market.
“At least two to three years before the stipulated time, start moving away from the high risk investments to low risk investments,” says Solanki. While some experts are of the view that one should move gradually from stocks to bonds over a period of time, the more conservative lot prefers to shift all the money to safe fixed deposits and liquid funds at least two years before the course begins. The idea here is not to take any risk with your child’s education.
Do not forget this. While accounting for your insurance needs, take into account the present value of this goal at risk free rate of interest. Buy a term insurance policy to that extent. In the above case, the sum assured should be equal to Rs 39.20 lakh assuming risk free rate of interest at 6 percent for 13 years.
A term life insurance policy on the life of a sponsor ensures that the kid completes his education even if the sponsor is not around.
Shun low return products
“Avoid purchasing low return traditional life insurance policies,” says Birani. “Some parents also make bank fixed deposits in their child’s name. But it does not help, given the poor post tax return they offer.”
If you are not comfortable with high return risky investment avenues such as equity funds, do consider investing in tax free investments options on fixed income side. “PPF is a very good way to accumulate money for your child’s education. You can open one in your child’s name. For girl child, Sukanya Samriddhi Yojana can also be tapped,” says Solanki. However, these products have rules pertaining to their maturities and hence opt for them if your goal’s time line and the product maturity are in line with each other.