While planning finances for your children, the first serious thought is enough to tell you that working with one provident fund, and desultory savings and deposits might not work. With increasingly expensive college and post-graduate education, and in cultures where marriages are still a family funded event, we are looking at events in the foreseeable future that will need a significant amount of capital to be laid out. Plus the ever-rising day-to-day expenses reduce our capacity to save.
Thus, financing the generation next needs a serious action plan!
The right place to start: Budgeting
Once you have arrived at a decision to get your family a structured “children’s financial plan”, you will need to do some homework before actually making your investment portfolios. This will help you decide intelligently the commitments that you can meet, as well as choose products that suit your profile.
What is the difference in your home expenses when you include your children’s expenses?
Take into account current and future expenses like child care, inclusion of children as dependents in mediclaim policies, schooling, summer camps, school projects, etc. In some cases, a couple may have to deal with the reduction or absence in the spouse’s income due to retrenchment, illness or other reasons. So, you can start off by monitoring your expenses on a weekly or on a monthly basis. [Look at our Budget Analyzer tool to get started.]
Understanding the change in budget is important to answer this question: Is your current cash flow sufficient to meet all your expenses and saving needs?
If yes, that is great. If no, you need to do some nifty planning to revise your spending habits and/or establish an alternative cash flow. The usual suspects when revising expenses include credit card spending, late fees paid on utility bills, and unplanned, spur of the moment shopping.
Also, year-end tax payments or investments towards tax rebate often throw cash savings out of gear. You might find that planning separately for lump-sum payment with recurring small monthly savings eases the stress. [Revising your home budget is an area of discourse by itself, and you may find talking to your peers, or researching on the net a rewarding exercise!]
Once you have a clear picture of your cash inflow and outflow over a reasonable period, you will be able to commit to your financial plan with greater confidence.
Creating a sound financial plan
Financial planning helps you manage your longer-term goals – higher education, marriage, estate settlement, etc. Generally, the earlier you set your financial plan in motion, the easier it is to meet loftier targets, without the need to take excessive risk or exposure. Beginning to plan as early as when your child is one year old is considered a safe point.
Some guidelines to help you ensure the soundness of your plan:
- Plan with real figures: You are typically planning for an event that will occur at least 15 years from now. Therefore the cost structure is bound to be much higher and many more options may be available to you. For example, you would notice that the cost of education, even locally in your country, has gone up drastically over the last decade or so. This trend is likely to continue, and if you don’t take this into consideration, even if your financial plan succeeds, you would fail to meet your goal.
- Make yourself aware of the current costs associated with higher education: While it is difficult to predict whether your one-year old would study engineering, medicine or management, knowing the costs of different streams will at least allow you to aim for an average corpus.
- Global education: If you are aiming for an international education for your child, you would need to research on the costs of the courses abroad. Add to the tuition fees, boarding, travel and various other associated expenses and you would arrive at the estimated cost of education.
- Next, account for inflation: What has been the average inflation rate in your country/the targeted country of education over the last decade? Use this rate to compute the likely cost of the similar courses 15-18 years later. This will give you a reasonably accurate “target amount” for your financial plan.
Let us consider an example where you have to support medical education for your child in the coming academic year. You would need to provide Rs. 20 lakh (for a private college) for a 5-year MBBS* programme. For a two-year management programme, however, the fees may vary from Rs. 7 lakh (inclusive of tuition and accommodation) in some of the top 10 management schools in Mumbai, to closer to Rs. 15-20 lakh if you aim for IIMs and other prestigious schools. For the sake of our example, let’s consider the average cost here – Rs. 10 lakh.
The rate of inflation for industrial workers at Consumer Price Index levels (CPI-IW) has been around 5.68% from 2003-04 to 2008-09 [Source: Labour Bureau of India]. Assuming that in developing countries the cost of education would rise more than the inflation rate, it is advisable that you work with a slightly higher inflation rate of 6%.
Using this, the target corpus would be:
Average Current Cost (Rs.)
Target Corpus (Rs.)
- Create separate portfolios for different goals: It is highly recommended that you do not club investments required for your child’s education with estate planning, your retirement, etc. For one, the time horizons may be different; which means that ideally you should be opting for different products of varying maturities for the best possible returns. Separate portfolios are also far easier to manage and revise in case there is a need to change anyone of the target amounts.
- Get cover for yourself: As you are the person driving this financial plan, it is imperative that any impact to your earning capacity is suitably covered. From a cost perspective, a term insurance would prove cheaper as the premiums tend to be lower than the endowment policies. However, if you are looking at an endowment policy, ensure that it covers the remainder of the premium payments in case something happens to the paying parent.
Select products intelligently: You are likely to evaluate the investment products in terms of their risk and possible returns. A point to remember here is that you are considering the product for a long-term horizon, with the objective of capital appreciation. So when you consider how “risky” a certain product is, look at its volatility over a comparable period of time. A telling example of this would be equity mutual funds – though recommended only for aggressive investors in the short-term, over horizons like 10-15 years, they prove to be far less volatile. Another risk you need to consider is failure to meet the investment objective. So, while a fixed deposit in a bank will give you 100% safety of capital, there is a very high risk that you may not meet your desired objective.
Let us look at some other aspects that you need to consider, and do a quick comparison of products. We have not considered two other features commonly used for product evaluation, liquidity, and income generation (example: dividend payouts or interest income), because the objective of this portfolio is pure capital appreciation.
Work with your adviser to arrive at the best asset allocation across these products so that your particular preferences for capital safety and capital growth are met.
- Review your portfolio periodically: Just planning for your investment portfolio is not enough. Certainly, this cannot be the last step before it is time for you to reap returns. Review the performance of your portfolio at least on a half-yearly basis to assess the performance of the selected products. It would also help to do more infrequent checks for a deeper analysis – has anything significant occurred to change your target amount? Is there any compelling market scenario that affects any one product to a large extent? Is the portfolio on its way to meet its goal?
- Avoid the urge, however compelling, to use this portfolio to play short-term strategies in the market. Once your asset allocation is decided, do your best to stick to it, and periodically rebalance it so that the portfolio is not overweight in volatile assets which may impact your targeted goals.
In conclusion, the success of this financial plan will offer you peace of mind for years to come. Once it pays off, all the effort would surely seem worth it! Happy investing!