"Someone's sitting in the shade today because someone planted a tree a long time ago," said the famous, billionaire investor Warren Buffett. To your children, you're the tree that provides and protects. How you manage your money today will directly impact your children's finances in the future. Therefore, it is imperative that you think deeply about financial planning for your children. Here are some dos and don'ts to help you along the way. What better time than the occasion of Children's Day to explore the subject.
Planning For The Long Term
Saving for your children is a long-term goal. The future's a confusing place, full of hitherto unknown factors that will come into play in your child's life.
# Do: Plan deeply. Take the help of an investment advisor to help create a roadmap to your family's financial future. Investing for your child's future requires considerable work and planning. You need to understand how much your child will need in terms of funding, in which years, and what the various factors are that will make the attainment of your goals easier or tougher.
# Don't: Wing it. Not everyone will have a nuanced understanding of the financial markets, macro-economics, the various financial products available, and their attached risks and rewards. If you wing it and get your plans wrong, you will suffer financial losses, lose precious time, and also find it harder to achieve your child's financial security.
When To Start Investing For Your Kids
Time is of the essence. It's as important to your financial plan as is the rate of return on your investment. Let's understand this better.
# Do: Start early. As soon as you can. Ideally, start when your child is born, because this will give you around 17-18 years before your child starts higher education and a few more years before they get married. A longer investment tenure allows you to better exploit the rewards of compounded growth. The earlier you start investing, the easier it will be for you to manage your goal because you're giving yourself a longer period of time to achieve it.
# Don't: Don’t start late. Let's say you want to save Rs. 1 crore for your child's higher education. If you invest Rs. 13,500 per month in an instrument providing average compounded annual returns of 13%, you'll achieve your goal in 17 years. However, if you started only five years late with the same investment plan, you'll have 12 years and your investment will grow to only Rs. 47 lakh. The alternative is that you'll need to invest Rs. 29,000 a month to achieve the same goal. The later you start, the further you fall behind in saving for your child.
Calculating Your Child's Money Needs
How can you decide how much is enough? We want to provide our children with the best possible opportunities and resources. But what does it take?
# Do: Take the education inflation rate into account while calculating your children's higher education costs. For example, a leading government-sponsored business school used to charge Rs. 2.5 lakh for its two-year business diploma in 2004. The same diploma costs Rs. 22.5 lakh in 2019. This implies that the cost of higher education at this college has grown at an average rate of 16% per annum in 15 years. Scary as it may sound, the same education will cost Rs. 2.02 crore in 2034 if the same rate of inflation is assumed. You can expect the cost of foreign and private education to inflate similarly.
# Don't: Don't make paper napkin calculations. You'll have to base your child's money requirements on actual research. You'll have to speak not just with your financial advisor but also with people in the know-family or friends who successfully funded their child's education, and decision-makers in the education sector who can provide some insights on the matter.
Where To Invest
Various factors contribute to a great investment-the tenure, investment allocation, the rate of return, risks, liquidity, and tax efficiency are key.
# Do: Diversify. You can invest in a mix of asset classes that provide with you a range of options in terms of returns, liquidity and tax efficiency. Financial assets such as PPF, mutual funds, and Sukanya Samriddhi (only for girl child below the age of 10 years) may be your best bet while saving for your children. Your portfolio should be bent towards instruments with the highest likelihood of goal attainment.
# Don't: Never put all your eggs in one basket-especially if that 'basket' is a low-returns instrument or is hard to liquidate in your time of need. Remember not to lock up a large part of your investment in instruments that provide low returns or those that may be hard to liquidate. For example, gold provides low returns; endowment plans provide low returns and also penalise premature withdrawals; and real estate investments may be hard to liquidate.
Understand Your Risk Appetite
In investments, the higher the risks, the higher the possibility of reward. When gunning for long-term financial goals such as saving for your children, it's advisable to invest (at least partly) in market-linked instruments that would provide high returns.
# Do: Invest in equity. Since your investment goal has a long tenure, you'll have several opportunities to recover from market corrections, average out your buying costs, and be in a better position to gain from market rises. Investing in mutual funds is one of the best ways to venture into equity investing. The 10-year term returns on dozens of equity mutual fund schemes exceed 12% per annum, much higher than what traditional investments may be able to offer.
# Don't: Don’t go only for investments which claim to guarantee returns, because there's enormous risk in these investments as well. For example, saving via a recurring deposit will give you 7% per annum, but if you're in the 30% tax-slab, your post-tax returns are just 4.9%, which will make it enormously hard for you to achieve your long-term targets.
Financial planning for your children is a complex task. However, as a responsible parent, you'll have to go through it to help your children achieve their dreams.
(The writer is CEO, BankBazaar.com)