Wednesday, May 18, 2011

Financial care of your kids

(This appears in a recent edition of Moneylife titled "No Child's play")

It bothers me when I see so many “children’s“ plans being floated by insurance companies. They lure you with sentimental but irrational and illogical advertisements. There are no real life examples and all of them promise you that if you enrol in their schemes, your children’s education is fully provided for.
In essence, each of them are ULIP’s, packaged with sentiment to lure you to a false sense of comfort. This play to your sentiments and the efficiency of the product is poor. The returns are not very high either and you would be better off with a mutual fund. I also see financial planners invariably include a dollop of ULIP’s in developing a financial plan for a child.
To me, ULIP is a product that should not exist. It is a very expensive way to save. The insurance cover that a ULIP provides is chickenfeed and not worth it at all. Ask yourself. Does a child need to be covered by insurance? Assuming something happens to the child, does it leave behind anyone who is financially dependent on it? So, get it in to your head that THE LAST THING A CHILD NEEDS IS TO BE COVERED BY INSURANCE. Yes, maybe the parent needs to be covered with ample life insurance, if he/she does not have enough money saved to provide for the child.
A simple invest of Rs.5,000 per month, will grow to around Rs.17 lakh at the end of 25 years, assuming a return of 8% p.a. This return is available, with zero risk, from a PPF account. Look at the power of compound interest. If the return were to be 15% p.a., the same investment would amount to a little over Rs.71 lakh! Now, if you get rid of the thought of insurance / ULIP out of your mind, we can look at where to park the money, where what returns can be got and what would be the tax implications. The first two things you have to firmly get in to your head is NOT TO PUT MONEY IN TO ANY INSURANCE OR ULIP for a child.
Why no ULIPs? Let me explain. The periodic amount you pay under ULIP’s is NOT fully invested. Of that, some part is deducted towards insurance (if insurance is provided), some towards ‘policy administration’ expenses, some towards ‘Fund Management Charge’. In addition, there COULD be charges such as “Surrender charges”, “Rider premium charges” etc., In effect, the minimum amount that will NOT be invested, out of your cheque, will be far in excess of 2.25%. Why 2.25%? Well, that is the typical maximum a mutual fund scheme can charge under ALL heads out of your investments. In effect, what you give to a mutual fund, you can be sure that at least 97.75% (for schemes that have a minimum corpus of Rs.400 crore) is invested. So, more of your money earns something.

Now, the key question is as to whether the fund management skills of the insurance companies are so fabulous that they earn a return that is so high (as compared to a mutual fund investment manager) that the net result is more money. To me, it is a no-brainer. I think both the persons are inter-changeable in terms of skills. And returns in the market place bear it out. So, I do not see any compelling reason for choosing an insurance company fund manager over a mutual fund industry person.
You have to provide for a child till he/she is at least 25 years of age. This is today’s minimum. Unfortunately, we do not let our children work after graduation and take care of their own post graduate studies.

The child will need money for regular schooling and the first lumpsum would perhaps come when the child enrols for graduation (I always wonder why the Americans call this as ‘undergraduate studies’?) and for post graduation. I assume that you will have sufficient money to enrol the child in a school of your preference and affordability and pay the tuition and related fees up to completion of the schooling.
Of course, the other expense Indian parents would like to provide for is for the marriage. With the Indian families still equating a marriage with frivolous pomp and giving, it is an expensive affair. And human nature being what it is, there is a compulsive tendency to show off. Alas, even the children get caught in to the spending trap and put pressure on their parents to spend more and more. So, saving for a marriage of a child (esp a girl child, since parents want to provide for jewellery also) is an open-ended thing. Whatever you save will be short. Given the poor state of the Indian education system and the intense level of competition, most children have to opt for ‘paid’ seats in private colleges. This number is unpredictable. Rather, we have to take in to what money we have and try to find an institution that would fit the bill.
In effect, the numbers are open-ended. Of course one can reasonably estimate present education costs. If we assume an annual increase of ten percent, it would mean a doubling of the requirement every ten years. At best, we can get a number which can be a goal, which has to be continuously re-set, depending on the costs of education, the likelihood of educational loans availability, the talent of the child etc.,
Instead of giving you concrete plans, let me give you a choice of two or three instruments that will help you to save for your children’s tomorrow. But keep one thing in mind. First, save for your retirement. Only after that, provide for the children (however cruel it sounds, it is more logical and ensures that you do not depend on your child by becoming a guest with them, in today’s world). Of course, you may have to sacrifice some of your own needs, but do not lose sight of it. Often, it may mean skipping some eating out or a holiday, to ensure that you can do so when you do not earn.
The first thing would be to start a PPF account in the name of the child, preferably in age one itself. Put in the maximum of Rs.70,000/- each year. This will start at the bottom of the returns table (hopefully) giving an annualised tax free return of 8%. The account is for 15 years and can be extended five years at a time thereafter. Initially, one of the parent can be a guardian and once the child attains majority, the account would be in his/her name.
Now, it is best to look at some equity mutual fund SIP’s. These should be reasonably expected to give a return of around 15% p.a. This has the highest risk on paper, but a SIP over 25 years minimises the risk of cycles in a very big way. I would recommend a mix of Index ETF and a couple of large diversified equity funds.
If you desire to have a stock of gold at the end of 20 years or so, without breaking in to a sweat, I would urge you to buy the Gold ETF’s. No physical storage, no making charges loss (surely fashions change), no wastage losses etc., You are locking in to actual gold at various prices over 20 years. At the time you want to buy jewellery, just sell of the ETF (long term capital gains, no taxes) and use the money to buy jewellery. The way inflation and nations are headed, gold may turn out be a great investment.
The third investment I would suggest, if you can, is to buy a plot of land for your child. Maybe in a tier two or three city, in a gated community. This will be a great gift to give your child. The house you live in can be used by you for doing a reverse mortgage and enjoy you sunset years.
If you still have money left over, then maybe you can look at direct equities through the SIP route. You can make a list of two to five bluechip stocks and keep buying them regularly. Choose companies that will be in business for long. Avoid second generation companies because they will be very likely to split in the next couple of decades. Perhaps, you could buy global shares also. Each year, you are allowed to use up to US $ 200,000 for investments overseas.
The basic thing is to realise that money is fungible. Many people advocate earmarking each saving for a particular expenditure or commitment. That is not realistic, because at the maturity point, one does not know the market cycles.

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