Investing for your child's education

There's no doubt that your child's education is a critical financial goal that is critical to ensuring good quality of life for your child.

One aspect in which your child's education goal differs from all others is that the date by which you need to attain this goal is absolutely fixed. If your investment plans towards owning a home or car are derailed for a couple of years, there's no need to panic because you can simply shift your goalposts on when you want to acquire your home or car. But you need to be prepared with an adequate corpus to fund your child's college degree by the time she turns 18.

Financial firms are well aware of the emotional value of your child's education goal and hard-sell a bunch of products designed to meet this goal. But, in our experience, plain vanilla mutual funds selected for their track record do a far better job of getting you to your child's education goal than these hyped-up 'child' plans.

Child ULIPs from insurance companies are a no-no on three counts. They divert part of your investment towards a term cover which can be bought at much lower costs separately. They carry minimum five-year lock-in periods that prevent you from switching to a better alternative if the plan delivers poor performance. Opaque labelling and costs also make it difficult for you to compare performance across different ULIPs to choose the best plan. We don't recommend special 'child schemes' from mutual funds either as restricting yourself to such special products can entail high exit loads and mediocre returns.

Having said this, here's a four-step process to planning out your child's education goal. Be sure to earmark a separate portfolio for this goal so that you won't withdraw early from it.

One, education costs in India inflate at far higher rates than most other items. An engineering degree which used to cost Rs 5-8 lakh just five-six years ago now costs upwards of Rs 12-18 lakh in the top institutions. Sought-after private institutions have also taken to building an annual-escalation clause into their fee structures. If you are a parent who aspires to send your ward overseas for studies, you need to budget not just for inflation but also for the impact of rupee depreciation of at least 4-5 per cent a year on your outgo. The high inflation rate on college degrees thus makes it very important for you to invest in high-return-earning investments to meet this goal.

Two, given that the only asset class that can beat inflation is equities, an early start becomes imperative. It isn't advisable to rely on a pure-equity portfolio for any goal that is less than five years away, because that would subject your corpus to market risks. This implies that you should have ideally started saving towards your child's education by the time your child turns eight, so that you have a comfortable 10 years' time to build your corpus.

An early start can also make a big difference to the amount you would need to save each month. To illustrate, assuming you have just 10 years to your child's education goal and target a generous corpus of Rs 30 lakh towards her degree and post-graduation at today's prices, the same degree would cost Rs 77.8 lakh by the time your child turns 18, assuming a 10 per cent inflation rate. That would require a monthly SIP of Rs 33,830 in a fund earning an annualised return of 12 per cent. Had you started five years before, the monthly investment needed would have been lower, at Rs 25,085.

Three, if you can make an early start, we recommend that you start equal SIPs in three flexi-cap funds to see you through your goal. If you have a higher risk appetite, you can use a combination of two multi-cap and one mid-cap fund.

Four, if you have missed the bus on an early start but still have five years to go, you can still use SIPs in hybrid funds. A college education that costs Rs 30 lakh in today's prices will cost about Rs 48.3 lakh in five years' time at a 10 per cent inflation rate. If you would like to stick to safe debt investments with an 8 per cent return, that would mean investing Rs 65,760 a month in debt fund SIPs. But if you choose a balanced or conservative hybrid fund with likely returns of 10 per cent, you can manage with lower SIPs of Rs 62,400 per month.

Five, be sure to buy adequate term cover so that in the event of your death, your family would still receive a sufficient sum assured to meet your child's college expenses. Buy a plain vanilla term plan online.

The above calculations would also give you an idea how large a sum you need to invest, even to meet a moderate education goal of Rs 30 lakh. The cost of an undergraduate degree in top overseas universities today hovers at Rs 1 crore plus. Therefore, though the thought of sending your child to an Ivy League school for her undergrad studies may be tempting, it needs to be a hard financial decision rather than an emotional one. You must set this goal only if your savings are large enough to fund it without cleaning out your own emergency savings or retirement corpus. After all, making your child understand your financial constraints and the value of money is as important to financial planning, as choosing the right schemes.