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Planning your children’s financial needs is a complex challenge. - Posted on: 29-06-2021

The hardest challenges in saving for the future is calculating your child's future money requirements

Planning your children’s financial needs is a complex challenge. It requires visualising the distant future, investing for needs yet unknown, tackling inflation, and frequently revisiting your plans for best results. You’re bound to make a few errors along the way. Let’s look at a few errors that you can avoid making and have a smoother path to the attainment of your children’s goals.

Don't be late
Time is money. Fortunately, while investing for your children, you have lots of time — at least 17 years from their birth to the moment they’ll start college. You should use this lengthy period to your advantage by starting to invest very early. This will provide you the power of compounding that helps your money grow at a faster rate. For example, assume you need Rs 30 lakh by the time your child turns 17. You can invest Rs 5,000 a month, and you will have a corpus of Rs 33.3 lakh in 17 years, assuming a CAGR of 12 per cent. However, if you started only five years late, you’ll need to invest Rs 10,500 per month to achieve the same goal. The earlier you start, the smaller your monthly investments can be. The later you get, the heavier your investment burden will be.

Take financial planner's advice
The many intricacies of long-term investing may evade a small investor. Without knowledge, you risk falling short of your financial target, which can have disastrous repercussions for your children’s future. Therefore, it's essential to speak to someone in the know — a financial planner, for example. This will help you pick the right investment tools, optimise your risks and returns, lower your taxes, and help you reach your goal in the optimum timeframe.

The money that child will need
One of the hardest challenges in saving for the future is calculating your child's future money requirements accurately. You need to be mindful of the costs of higher education as well as the rate of education inflation, which is higher than the rate of cost inflation. For example, a two-year MBA at IIM Calcutta cost around Rs 2.5 lakh in 2004. In 15 years, the cost has grown at around 16 per cent per annum to Rs 22.50 lakh. The average yearly inflation in the same period was around seven per cent. Therefore, while creating your child’s college funds, it’s essential to pick instruments which offer high post-tax returns.

Don't lock up all your money in realty
It’s tempting to lock up vast amounts of money in traditional and conservative instruments like property. However, property is rarely a liquid investment as it may take months or years to dispose of it, leaving you with a liquidity problem in the moment you need your money.

Also, if the property is a house, you cannot sell it partially, unlike a financial asset that can be partially liquidated for an immediate need. So this is why it’s important to invest in diverse instruments that provide returns, capital safety, and liquidity.

'Safe' investments may be risky
As demonstrated above, education inflation is very high. You may think that locking up money in fixed deposits, PPF or even Sukanya Samriddhi may be enough. However, these investments contain inflation risk, i.e., you may not be able to beat education inflation and fall short of your required corpus. This is another reason why you shouldn’t use fixed deposits as a long-term investment tool. An eight per cent FD actually returns only 5.6 per cent after taxes if you're in the 30 per cent tax slab. Therefore, since saving for your children is a long-term exercise, consider investing in equity as well because of the potential for high returns. The long-term returns from top-rated equity mutual funds, for example,comfortably exceed returns from small savings schemes. Consult your financial advisor for the best mix of investments for your children.

Look beyond child plans
In an ideal world, you should invest and insure separately and not mix the two. Before investing in child plans (which combine life insurance with debt investment), invest-ors often don’t pause to ask what the annual rate of return on their investment will be. The least your investment should return is what Public Provident Fund returns (currently 7.9 per cent per annum, tax-free) or what Sukanya Samriddhi returns (currently 8.4 per cent per annum, also tax-free).

Equity mutual funds become especially important in this regard, because dozens of schemes have provided 10-year returns exceeding 12 per cent per annum. If the returns from achild plan do not compare favourably with these options, and if there are penalties for prematurely exiting it, you should avoid getting into it.

Insure adequately
Lastly, ensure your family has adequate insurance coverage against various risks. As a person with dependent children, you must have a term plan with sum assured worth at least 20 times your current annual income-or more, if your family's financial risks are bigger. You must also have adequate health covers for all family members. The coverage would ensure that the financial plans for your children will not get derailed in case of your untimely death or pressing medical problems.

Lastly, do not mix up the investments for your children with other essential investments you need to make, such as creating your retirement fund. Speak to your financial advisor to create a long-term plan that allows you to meet all your future goals without putting a lot of strain on your finances today.