Invest the biggest chunk of your long-term savings in equities with some exposure to debt and gold
Providing a trouble-free and safe life to the child tops almost every parent's wish list. It relates to his or her social, physical and financial safety.
When it comes to financial safety, a major challenge for parents is about putting in place a safety net for the child's higher education, when she is in her teens and crossing into the 20s, and then for her wedding.
The main problem here is that while the rate of inflation is currently 8-10%, the cost of education is rising at a much faster clip. In government institutions it is at about 15% per annum while in the private institutions the rise is over 20%. And the cost of wedding, by some estimates, is also rising at the rate of about 20% per year.
By common logic, if you are saving for your child and getting a return of say about 10%, by the time your child is ready for higher education, the corpus you would build would not be enough. This is because while you are earning at the rate of 10% per annum, the market rate of her education is rising at 15%, around 5 percentage points higher than the returns.
As a solution to this problem, financial planners and advisors suggest a twin strategy. For one, you should start saving for your child as early as possible. And the second one is to put in a large sum of the savings into equity mutual funds, or if you are trained well then directly into equities.
Starting early would help you bring in the power of compounding to your advantage. Take this simple example: Suppose you start saving Rs 10,000 per month for your child soon after she is born and get an average return of 15% per annum. At that rate, when she is 20 and ready for higher education, the corpus would be close to Rs 1.5 crore. If you decide to start saving when she is 5 years old, at 20 the corpus would be close to Rs 67 lakh, that is less than half of what it would be if you had started just five years earlier.
Let's see how investing a major chunk of the money in equity funds, which is also a proxy for investing in equities, can help build a bigger corpus. Over the long term, say 10-15-20 years, equities are known to give returns that beat inflation while bank fixed deposits (FDs) just about match the rate of inflation or at times even fall short. If you invest in equity funds, you can reasonably expect to get a 15% yearly return while in bank FDs will pay you an average rate of 8%. If you put Rs 10,000 every month in FDs giving you 8% per annum, your total corpus, when your child is 20 years old, would be about Rs 59 lakh. Compared to this, if you manage to get 15% per annum by investing in equity funds, the corpus would be more than 2.5 times what you would get from FDs.
When you have 10-15-20 years on your side, equity mutual funds are the best option Settle for monthly SIP in any good equity scheme. In addition, any lump sum that you can afford to invest for your child you should put into the same.
Some prefer to invest in gold for their child, but like FDs, the return on gold is also very much linked to the rate of inflation. That is also the reason gold is often taken as a hedge against inflation. So investing in gold, of all probability, will not fetch you as much as you require for your child when your need the money either for her education or wedding,or both.
There are other combinations. And if you are not experienced enough about the investment products, it is preferred you take the help from a professional financial advisor or planner.
In this page, Vidya Bala's article dwells on the basics of a financial plan for your child while N Rajesh introduces the basics of some of the investment products one could look at.
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