Using mutual funds to plan for and fund your child’s education

TomorrowMakers ™

Using mutual funds to plan for and fund your child’s education

30 December 2016
Inflation in education related expenses is expected to increase faster than average inflation. This means that depending on debt instruments to plan for your child’s education needs even 20 years before time, is no longer a feasible option.

Consider this.

While an engineering course costs on average, Rs. 6 Lakhs today, it will cost Rs. 33 Lakhs in 2033. While a degree in medicine costs on average Rs. 12 Lakhs, it will cost around Rs. 67 Lakhs in 2033.

It is no surprise then that the major worry of 61.7% of parents is the rising cost of education, beating even “not saving enough” and “insufficient knowledge of investment options”.

Thus, moving beyond debt to more profitable equity investment options is the only logical move.

Related: Investment Options- Thinking Beyond the Obvious

The only way to meet this large commitment is through substantially high investment returns.

Typically, most parents end up choosing routes like fixed income oriented child plans or long-term (and very safe) small savings schemes like PPF or Fixed Deposits (FDs) with a bank, both of which offer post-tax returns of as low as 6-7%. The result is that while the education kitty is safe, it doesn’t swell too much.

Related: Things you didn’t know about saving tax [Infographic]

Experts agree that over the long term (say 15-20 years, which would be the investment horizon for an education plan), equities remain the best investment option from a risk-reward perspective.

The 30-year Compound Annual Growth Rate (CAGR) on the blue chip BSE Sensex currently stands at a handsome 17%. Also, remember that capital gains on the sale of equities with a holding period above 1 year are tax-free. Add to this the approximate 1-1.5% annual dividend yield and you have a compelling economic argument for equities.

Related: Equity Linked Savings Schemes: High Returns Tax Savings (Part 1)

For those who do not have the time or the inclination to invest directly in equities, mutual funds are the ideal route for multiple reasons.

  • Firstly, seasoned fund managers make investments on behalf of investors like you after deliberation, research, analysis and discussion.
  • Secondly, mutual fund portfolios are well diversified, hence providing a cushion from concentration risk.
  • Thirdly, mutual funds provide the kind of flexibility that is vital for an education fund.
  • Fourthly, long term mutual funds are ideal since they generate the highest returns in the long run, despite short term volatility.

Fifthly, the minimum you can expect from a pure equity mutual fund investment is around 10-12%.

Perhaps the biggest advantage of using mutual funds for a college education fund is that as you get closer to the point in time when you need the money to fund your child’s education, you can simply migrate from a high risk, high return mutual fund into one that’s slightly less risky i.e. as the investment horizon shrinks, risk appetite reduces and hopefully so does the requirement for high returns.

Switching the investment around into lower risk funds can be done at the click of a button. All this flexibility and access to professional investing skills comes at a nominal annual asset management fee of perhaps 1.5-2.5%

Related: ULIPS vs Mutual Funds- Where should you invest?

Steps to follow to set up and maintain the education fund using mutual funds:

  • Open a minor folio with joint operation by both parents
  • Set up SIPs for maximum possible amounts that are comfortable
  • Review SIP amounts once a year and increase
  • Determine asset allocation based on investment horizon
  • Review investment performance and asset allocation periodically (about once a year)
  • Move the required amount of funds into a liquid fund a few months prior to payout

Important Questions to Answer:

  • How much do I have to save every month?

The amount you save every month depends on the age of your child and how many years are available before you will need to use these funds for his or her education. If you will need it 10 years from now, you would have to save more than if you need it 15 years from now.  Use this Education Cost Calculator for more info.

  • How much should I aim to have at the end of it?

Depends on what kind of education you want to provide for your child. Make sure you fix an amount in your mind before you even start. For this you first need to find out the cost of educating your child in India.

If you have any particular questions about funding your child’s future, leave them below.

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