Monday, October 14, 2013

How To Plan Your Childs Financial Future and Do It Well!!!


Today is Vijaya-Dashami, a day that is considered auspicious for all good things for our future. So, todays aim is to start planning for something that is most important and crucial for all of us...

Becoming a parent is a great step forward for any couple. It brings in tons of joy and happiness to not only the couple but also to their parents, relatives, friends etc. However, along with this happiness comes a great deal of responsibility and financial burden that has to be prudently planned. A Parent who does not plan for his/her children’s future is similar to a batsman entering the pitch to bat against Shoaib Akhtar or Brett Lee without Helmets, Pads, Elbow Guard etc. Eventually they will end up getting hurt, unless of course they get out first ball.

Analogies apart, being a good parent is not only about being affectionate and caring on our kids, it is also about planning for a safe financial future for our kids and making sure that we stick to the plan over the next 15-20 years when our kid will actually need the money...

Why Plan for our Kids Future?

This is the million dollar question. Every parent dreams of their kids to have the best education, to go to the best college etc. For parents of the girl child in India comes the added responsibility of planning for their daughter’s wedding. All these goals that you set in your mind about your children require money and a lot of it. Unless you start planning now, there is a chance that you may face a budgetary constraint many years down the line when your kid is ready to go to college or is ready to get married.

Are you thinking?

My kid's college or wedding is so far away. I will definitely save up money for it by then...

This article does not doubt your commitment or love towards your kids. Instead this article is about starting the thought process that will help you save up the kind of money you need, in time for the big spend...


How To Calculate The Future Money Requirement?

Now that we have established that you are a responsible parent and are going to save up money for your children’s future, the next step is to plan and identify how much money you actually need. For ex: The fee in a reputed Engineering College these days in Chennai works out to around 50,000 to 75,000 per year. So, for a 4 year education including special fee, exam fee and all those unknown fees colleges rip us off, the total fee for education would work out to approx. 5 Lacs.

The next step is calculating when your kid will be joining college. Let us say your kid is 1 year old now and will join college when he is 19 years old, you have 18 years to accumulate this money.

Lastly, you need to take into account inflation because when I studied Engineering a decade ago, my fee per year was approx. 20,000 whereas the fee now has almost doubled in just 10 years. Who knows what will happen 18 years from now? But, for simple calculation purposes let us assume Inflation will be at 10% per year.

Now, we have all the requisite information to calculate the "How Much" part. The formula for that is:

Amount * (1 + Inflation Rate %) ^ No. of Years.

So just plug in your numbers and you get:

5,00,000 * (1 + 10/100) ^ 18

500000 * 1.1^18

27,79,958.66

So, at the end of 18 years, you will need almost 28 lacs for an education that is costing 5 lacs today.


So, How to Accumulate the money?

Once you know how much money you need, the next step is to start accumulating the corpus. You have two options - Either do one time lump sum investments or make monthly contributions. Let us take our earlier example where we need 27.8 lacs for our kids’ education.

One Time Contribution: If you put 5 lacs today into a Fixed Deposit that pays you 10% interest which is compounded every year once, you will end up with exactly this 27.8 lacs that you need for your child's education 18 years from now. So, if you have surplus in your hand and want to ensure that your kid gets the best education, just put the money into a fixed deposit for 18 years and just forget about it. When your kid is ready for college, so will the money to fund his education.

Formula to calculate the Maturity Amount is: Amount * (1 + Rate of Returns %) ^ No. of Years.

Monthly Contributions: To accumulate this much money, you would need to invest 5000 rupees every month for the course of the next 18 years into an investment that pays you at least 9% returns per annum. Doing so will accumulate 27 lacs at the end of 18 years

This formula is a little bit complicated, so I suggest you use the SIP Returns Calculator Widget embedded in our Retirement Planning Home Page. Click Here to view the page.


So, What Next?

You now know how to calculate the future value required for a certain event and how to calculate the investment required to achieve it. The next step is to make sure we cover everything. Two of the key events in our kid's future which will need a big influx of cash are:

1. Higher Education (Degree, Post-Graduation, Masters etc.)
2. Marriage

If you want to plan for anything else, you can always include the same into your financial plan for your child.

Step 1: Calculate the Target Timeline. Ex: Higher Education - 18 years, Marriage 25 years etc.

Step 2: Calculate the amount required for each event. Use the formula in the section above

Step 3: Calculate the amount you need to invest every month (This is much easier than one time lump sum investments). But, if you have surplus, don’t think too much, go ahead and invest it.

Step 4: Keep track of your investment every 3 months and make adjustments if required...


Points to Remember:

The following are some points you need to remember while planning for our children’s future...

1. One of the biggest mistakes people do is dipping into this kind of corpus every time they need money. This will significantly deplete the final maturity value. As we are trying to save money for our children’s future, let us take a decision that we will not be touching this unless it is a real life & death kind of emergency. If you want to go for a cruise or get that luxury car, don’t even think about touching this corpus...

2. Proper Asset Allocation is vital. During the initial stages of the saving plan, you can try an Aggressive approach and keep a healthy allocation towards Equities because in the long run, they are the best asset class. As your target goal comes nearer, start shifting your assets slowly towards a Balanced approach and when your goal is just a couple of years away, go in for a conservative approach.

For ex: If I were starting an SIP for Rs. 5000/- every month for the next 15 years for my Sons education, I would choose a Diversified Equity or a Large Cap Mutual Fund Initially. After 8 years I will switch over the corpus into a Balanced Fund and continue my SIP. After 12 years I will switch over to a Debt fund or start up a FD for the full corpus as-on-date and start up a Recurring Deposit with the bank. This way, am ensuring that my overall corpus does not get affected by the short-term stock market volatilities.

3. DO NOT get carried away by fancy financial products especially ULIPs. Read the details carefully, analyze the pros and cons before you make any investment decisions. Remember that the Insurance Agent is getting paid to sweet-talk you into buying those products. You are the one who will be affected if the product does not do what it is supposed to. Remember an article titled Financial Resolution No. 3: I will not blindly trust my Insurance or Investment Advisor? Please Read it once...

A TIP for the Parent Who is Extremely Busy:

Most of the children’s future themed ULIP Products have great advertising campaigns with lots of Insurance Agents and Banks selling them aggressively. The catch here is that, these are just standard ULIP plans which have been sugar coated with the key-word "Children" to appeal to the parents of today. If the products were that amazing in protecting our children’s future, the agents and banks need not have to get paid a hefty commission just to sell these to you and me.

Anyways, if you are someone who cannot spend so much time into deciding on Investment options, Asset Allocation etc., then, these ULIP options are good provided you are willing to incur the cost of the advertisement campaign, the commission paid out to the person who sells you the policy etc. However, this is obviously much better than doing no planning at all...

Some Last Words:

On an average, if someone actively tracks & manages his/her portfolio even if it is just Bank Fixed Deposits or Mutual Funds, they will probably make at least 2-3% more in profit when compared to someone who selects a ULIP scheme that invests in the same category. This is not because the people who manage those ULIP schemes are incompetent. They are obviously more competent than you and me but the fees and charges they end up paying to all the parties involved is just so much higher that it eats into the profits from the investors perspective...

But, as long as you are able to do some sort of planning for your kids future, that would be a great start..

Happy Planning & Investing!!!


2 comments:

  1. Anand, I fully agree in "Some Last Word". I do it myself and I have grown smarter and smarter day by day. People think you need to go to Havard to make money. But the truth is otherwise. Ukmitra

    ReplyDelete

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