Every parent endeavours to provide the best to his/her child –– be it education, lifestyle, and even getting them married in pomp and style. Hard-earned money is saved and invested in a variety of investment avenues, including mutual funds.
Recently, on World’s Children’s Day --- November 20th --- a number of articles on ‘Children’s Fund’ made the rounds in the press -- some even advocating investments in them. But is a ‘Children’s Fund the only solution to plan a child’s future needs?
Investors often get carried away by names and perceived brand value when they are deciding which mutual funds to invest in.
But this is not the best approach to pick the best mutual fund schemes while planning for the envisioned financial goals. Similarly, investing in an ad-hoc manner or mirroring the portfolio of the next-door neighbour, friend, or a family member is not in the best interest of the investor -- because each one’s risk profile, investment objectives, financial goals, and the time horizon to accomplish goals are different. You see, a well-thought-out strategy and incisive approach are necessary.
Financial advisors should ideally handhold and prudently advise clients’ when approached to plan for a child’s future needs (viz. education and wedding expenses). Merely recommending a ‘Children’s Fund’ is not the solution.
A “Childrens Fund” has a lock-in of 5 years or until the child attains the age of majority (18 years), whichever is earlier. So, given the lock-in of 5 years, the financial advisor needs to carefully assess the liquidity needs of the client/investor – i.e. when will the money be required to fulfil the financial goal.
Every investor’s/client’s need and time horizon before the child’s future goal befalls could be different.
Before the financial advisor recommends investment avenues, the following needs to be assessed:
- The current age of the child.
- The number of years in hand the investor has before the child’s future goal realises.
- The financial health of the parent and a breadwinner of the family (income & expenses, assets &liabilities, etc.).
- Does the breadwinner of the family have an optimal insurance cover (This is because the biggest potential setback to a child's future is the demise of the breadwinner).
- The level of risk the parent can afford when planning for child’s future needs (Counsel the parent to take calculated risk in pursuit of achieving better returns to accomplish the goal/s -- that is the need of the hour, as inflation is eroding the purchasing power of hard-earned money).
This will help set the asset allocation right and pick appropriate types of mutual funds for the portfolio.
Say, the investor wants to plan for his/her child’s higher education needs, here is a 5-step approach financial advisors should follow:
Step #1: Estimate the cost of education prudently. When you do so, conservatively factor in 8-10% inflation for education expenses. And do not neglect to account for associated costs such as application fees, counselling fees, and expenses pertaining to preparatory exams, etc.
Step #2: Expect the unexpected. This means the financial advisor should not forget to account for the rise in fees, examination/tests fees, coaching class fees, payment towards educational excursions, and the exchange rate in case of education abroad, hostel accommodation, etc. This will help estimate a realistic budget.
Step #3: Ascertain the portion of the existing assets or savings of the investor/client that can be assigned for the child’s future needs.
Step #4: Make sure the asset allocation is set right (based on the risk profile, broader investment objectives, and the time horizon in hand to accomplish the goal) before recommending investment avenues.
Step #5: Work out periodic investments that the investor/client needs to do and get started to build the corpus. Encourage him/her to invest smartly and systematically, via Systematic Investment Plans (SIP) --
which is a rewarding strategy in itself to generate wealth.
If this is thoughtfully done, the parent does not need to apply for an education loan at a demanding rate of interest to fulfil his/her child’s education needs. Higher education needs of the child can be met through productive investments.
A well-performing “Children’s Fund” with a commendable track record can be one of the investment solutions; and NOT THE ONLY SOLUTION. The financial advisor should carefully evaluate the scheme for its returns, risk ratio, performance across market cycles (bulls and bears), portfolio characteristics, fund manager credentials, the number of schemes managed by the fund manager, the expense ratio of the scheme, the investment processes and systems at the mutual fund house, among a host of other factors before recommending a ‘Children’s
Remember, given the lock-in period, the investor/client will not to be able to switch to another worthy scheme. Plus, as mentioned earlier, factors such as liquidity needs of the client/investor and the time horizon before the child’s future goal befalls must be considered.
Ideally, to address a child’s future needs, financial advisors should recommend a bouquet of investment instruments --- across asset class, categories, and sub-categories --- to derive the benefit of diversification.
Depending on the risk appetite, if the child’s future goal is more than 10 years away, value funds, , an ESG Fund, multi-cap funds can be considered.However, if the investment time horizon is between 5 to 10 years, a large-cap fund, large-and-mid cap fund, and a multi-cap fund, may be considered.While for a 3 to 5 years’ time horizon before the goal realises, among the equity-oriented, a large-cap fund would be a suitable choice.
Moreover, when the time horizon on the goal is nearing, i.e. 3 years or less, the investment should be shifted to safer avenues such as bank fixed deposits, liquid funds and/overnight funds. And don’t forget to review the investment portfolio at least once a year and make changes, if necessary.
Financial planning and investing are highly personal, customised activities. Financial advisors should make a conscious effort to be pragmatic and prudent in their approach while paving the path to wealth creation for investors/clients.
Happy Planning & Investing!
Mr. Jimmy A. Patel, MD & CEO Quantum