Investment Options For Your Child’s Future

[Child's Future Planning Series]

Session 2: Investment Options For Your Child's Future

We are glad to have you with us for our 2nd Session on Child's Future Planning – and that is…

Investment Options For Your Child's Future

To plan for your child’s future – be it their education, lifestyle, marriage etc. – you have a galore of investment avenues today. But planning and investing wisely, is no child’s play.

Selection can often be a perplexing and even a daunting task.

Moreover, you need to select an appropriate mix of various asset classes (such as equity, debt, gold and real estate) to optimally position your portfolio and strike a right asset allocation balance as you progress towards each of the financial goals set for your children’s better future.

Simply, saving and investing in an ad-hoc manner may not help. You need to identify the appropriate investment avenues at an opportune time so as to meet your financial goals.

So, in this session we’ll explain the rationale behind investing in various asset classes and the avenues therein.

What should you look at before investing…

You need to assess…

  • The age of your child
  • Number of years you have in hand before the goals you’re planning for your little one to realise. This would define the investment horizon.
  • Your own financial health as a parent and as a breadwinner of the family (i.e. income, expenses, assets, liabilities, insurance coverage, among a host of other factors should be considered.)
  • Are you insured enough as the breadwinner of the family? – One of the biggest potential setbacks to a child's education is the demise of the breadwinner in the family and the lack of insurance. So, prudently assess if you have enough life and health insurance to cover at least the school fees of your child. It is recommended to avoid pre-packaged life insurance plans that provide both life insurance and investment in a single instrument. Choose a term plan which is pure life insurance.
  • Risk taking ability: Many a times, parents adopt a risk-averse approach to meet their child’s goals... Looking at inflation and rising cost of goals like higher education, taking calculated risks to earn higher investment returns is the need of the hour, especially if you have a longer investment horizon.

If you prudently consider these facets, it would enable you to optimally invest your hard earned money for your child’s wellbeing.

What are your investment options?

  • Equity as an asset class has the potential to beat inflation. So, effectively you may enjoy comparatively better inflation-adjusted returns
  • Yes, equity investing is volatile and risky. Due to this, many investors are hesitant to put their savings in the stock market. But, as a long-term investment avenue to address financial goals; equities have historically shown that the risks are relatively lower and returns are able to beat inflation.
  • Equity mutual funds are a convenient option to invest in stocks through a professional fund manager employed by the mutual fund company.
  • Mutual funds invest in multiple stocks across sectors thus offering diversification which further helps to reduce risk / volatility. Plus, your hard-earned money is managed by professional fund managers
  • However, it is vital to wisely select equity mutual fund schemes for your portfolio, to leave you with only the best for your investment portfolio
  • You may opt for diversified equity mutual funds as they’re relatively less risky vis-à-vis sectoral / thematic funds – which expose investors to sector/theme specific risk...
For picking mutual funds study:
  • Who’s the fund sponsor;
  • Investment philosophy, process & systems at the fund house;
  • Investment objective and Investment style;
  • Portfolio characteristics;
  • Fund manager’s experience;
  • Historical returns;
  • Performance across market cycles (i.e. during bull phase and bear phase);
  • Risk ratios;
  • Expense ratio;
  • Exit load;
  • Tax implications;
  • Investor service and transparency; and
  • Do a peer comparison

You may seek the services of a trusted financial advisor for choosing the right mutual fund schemes in case you aren’t well-versed with the instrument.

  • Investing in debt or fixed income instruments can help to de-risk and add relative stability to your portfolio
  • It can also help you address your short-term goals since equity is a long-term investment option.
  • You may invest in debt mutual funds such as liquid funds, ultra-short term debt funds, income funds, gilt funds, Monthly Income Plans etc. You can select these debt mutual schemes based on your investment horizon which may vary from a few days to a few months or a few years. There is a debt fund scheme for every investment horizon.
  • Compared to other traditional fixed income investment avenues, debt mutual funds are tax efficient
  • If you hold units of non-equity mutual funds (including debt mutual fund schemes) for more than 36 months, they offer an indexation benefit. This means, you pay tax only on gains that are over and above the inflation rate. So, if you earn 10% returns and inflation is 6%, you pay tax only on the differential 4% returns.
While investing in debt mutual funds, besides the investment philosophy, processes & systems, pay attention to:
  • Modified Duration (It signifies how sensitive the debt portfolio is to interest rate movement.) 
  • Average Maturity (It depicts the average maturity profile of the debt portfolio. Lower the average maturity, the less vulnerable is portfolio to the interest rate movements. It should ideally be congruent with the suitable time horizon meant for the particular category in which the debt mutual fund scheme is into consideration. If your investment horizon is less than 3 years before a goal befalls, select a debt mutual fund with a lower average maturity.) 
  • Credit ratings (It depicts the quality of debt portfolio. ‘AAA’ rating is the highest credit rating, and has the least default risk. Greater the proportion of quality rated instruments, the better it is.)
  • Yield-To-Maturity (YTM) (It is an indicator of an approximate yield from the bond portfolio the fund manager has invested in. If the fund manager has invested in bonds with higher coupon, the portfolio yield will be higher. 

    In a steady interest rate scenario, YTM can be used as an approximate measure of the returns that a fund can generate. However, in a falling-interest scenario this will not hold true.)

  • Gold occupies emotional space and special fascination among many Indians. Besides, it’s looked upon as a store of value and a hedge against inflation, during economic uncertainties.
  • Like debt, Gold is also an effective portfolio diversifier.
  • Instead of physical gold you may wish to buy gold ETFs or gold saving funds, which offer gold in paperless form with the added advantages of purity and smaller ticket size.

Why avoid investing in physical gold…
  • Physical gold is often sold at a premium by jewellers
  • There’s a High holding cost (in the form of bank locker rent);
  • Quality is a question (if not hallmarked)
  • You may not get the correct market value at the time of sale and may need to sell at a discount to the market price
  • Making charges are added to the cost even if one buys coins and bars
On the other hand, investing in gold ETFs and/or gold saving funds has its merits…
  • It’s Convenient and paperless (Gold ETFs are traded on the stock exchange. They can be easily be bought and sold at market value. Gold savings funds (which are Gold Fund of Funds where the underlying fund is a Gold ETF) can also be purchased in paperless form. Hence you do not have to worry about storage and security aspects like physical gold.)
  • It is also Low cost (it saves the cost of holding physical gold in a bank locker, besides making charges. The only cost that you will be incurring here is the cost of maintaining a demat account (in case of Gold ETFs) and the nominal brokerage for transacting in gold ETFs. And if you opt for gold saving funds, you even avoid paying these, but bear only an expense ratio in the fund you invest in. But please note that the expense ratio in a Gold ETF is lower than in a Gold Fund of Fund)
  • Don’t have to worry about the quality of gold you own (because as per the Securities and Exchange Board of India (SEBI) regulations, the purity of underlying gold in gold ETFs should be 0.995 fineness and above.) 
  • No premium to be paid (You pay the prevailing market price excluding the expense ratio)
  • Since gold ETFs are traded on the exchange, they can be easily sold in the secondary market on a real-time basis at the prevailing market price. This saves the hassles of visiting a jeweller. For gold savings fund, the investment can be redeemed with the fund house at the prevailing NAV.)

Real Estate
  • A house property is meant to fulfil your basic need for shelter. So, if you’re planning to purchase a house to live in i.e. a primary home, sure, go ahead! This can make your child feel financially secure.
  • But if you’re availing a home loan to fulfil this goal, make sure you’re within your means. Meaning, take only that much loan that you’re able to service/repay. Don’t overdo it!
  • When you purchase a house property for your own dwelling, capital appreciation shouldn’t be the prime focus. Instead pay attention to aspects such as…
    • Locality
    • Who is the builder? (Is he listed or recognised with the housing finance companies in case if you want to avail a home loan facility)
    • What has been his track record?
    • Does he completes the construction of his projects as per schedule?
    • Time lag for getting the possession (in case of on-going construction)
    • Age of the property (in case of already constructed properties)
    • Has a society being formed
    • Is the property rate competitive vis-à-vis the amenities, if any
    • Construction quality
    • Title of the property (to ensure that it’s free from any encumbrances and litigations)
    • Whether statutory permissions are in place
    • Maintenance cost

    Remember; if you’re planning to buy a house property to live in, any time is a good time to time invest. But don’t forget to assess the factors we mentioned, among many others while you crack a deal.

    Key Points to Consider before Investing in...
    (Equity, debt, gold and real estate...)
    Traits Asset Classes
    Equity Debt Gold Real Estate
    Return High

    [Capital Appreciation & Dividend Income]

    [Interest Income/ capital appreciation/ dividends]

    [Capital Appreciation]
    Medium to High

    [Capital Appreciation & Rental Income]
    Risk High Moderate To Low Moderate High
    Liquidity High High Medium for physical gold and high for Gold ETFs/ Funds Low
    Taxation* STCG# - Taxable 

    LTCG## - Tax free

    Dividend (if less than Rs.10 lakh^)– Tax free
    Interest Income/ capital gains/ dividends (on debt mutual funds)-Taxable Capital gains-Taxable Capital gains/

    Rental Income-Taxable
    Suitability When the investment horizon is more than 5 years and risk appetite is high When the investment horizon is short from few days to a few months to a few years, and risk appetite is low to moderate When the investment horizon is long and risk appetite is moderate When the investment horizon is long and the risk appetite is high
    #: Short Term Capital Gain Tax

    ##: Long Term Capital Gain Tax

    * As per current tax laws. Please consult your financial advisor and/ or tax consultant for implications of the investment/participation in the aforesaid asset classes.

    ^Dividend in excess of INR 10 Lakh from Domestic companies has become taxable for Individuals and HUF from FY 16-17 and for other categories from FY 17-18

    The table here compares the various parameters for each asset class we just talked about. 

    You see, while equity offers you opportunity to earn high returns while addressing to your child’s future goals (be it education and marriage), it comes with high risk. But it offers you high liquidity and favourable tax status. Thus when the investment horizon to the goal is longer, you may take the risk and invest in equity investment avenues.

    If you have a shorter investment horizon, it is better to follow a conservative approach and invest only in debt instruments as they carry medium-low risk... Debt funds are generally more tax-efficient than traditional debt instruments.

    Gold can be an effective portfolio diversifier if the investment horizon is longer, where taking moderate risk is warranted for capital appreciation. 

    So, pick your investment options prudently for long-term financial well-being of your children. The objective is to make productive investments; and the earlier you start to invest, the better it is.

    Besides, as earning parents, ensure that you’re optimally insured (both for life and health), to avoid a financial setback in case an untoward event were to happen to you. It is recommended that while insuring for life, buy pure term insurance plan and do not co-mingle investment with insurance as some products offer a combination of both.

    Before we wrap our today’s learning session, here are a few vital…

    Points to Remember…
    • Choose wisely from a galore of investment avenues to plan for your child future needs
    • As a parent, conduct a financial health check-up. It’ll give a better sense of where you stand.
    • Judge the time horizon until your child’s financial goal befalls to select investment avenues appropriately
    • Do not hesitate to take a little higher risk to address your child’s future needs given the rising cost of living and inflation. Remember, over the long-term, equity as an asset class has the potential to provide higher inflation-adjusted returns. Invest in mutual funds for professional fund management, diversification, liquidity, and for products across risk appetites and investment horizons. But select mutual funds wisely!
    • Invest in debt instruments to de-risk your portfolio, and especially when the goal horizon is shorter.
    • Gold is a store of value, a hedge against inflation and during economic uncertainties, as well as an effective portfolio diversifier; so own some in your portfolio, but invest in gold the smart way – via gold ETFs and gold saving funds.
    • If you want to buy a house property for your own dwelling, go ahead! But make a prudent choice taking cognisance of the factors we discussed. 
    • Don’t forget to follow an asset allocation approach, as it can not only help you clock an optimal rate of return, but also protect the value of the portfolio amid uncertain economic conditions and market volatility.
    • As a breadwinner of the family, don’t forget to optimally insure yourself (for health and life). In case of an untoward event, proceeds from insurance claim can come to your rescue.
    •  Start investing early for your child’s future needs, to enjoy better power of compounding.

    So to end our learning exercise today, we now invite you to test your learning by taking up this simple quiz (and win exciting prizes!)

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