Steep increase in the cost of higher education is leading most parents to avail education loans for financing their children’s higher education. However, availing education loans risks leaving their children with steep debt burdens, especially in the initial years of their careers. An economic downturn or a stagnant job market can further increase their financial woes. The best alternative is to accumulate an adequate corpus to meet their ward’s higher education dreams.
Here is a step-by-step guide for creating your child’s higher education corpus.
Set a target for the corpus
While it is not easy for parents to predict the career choices for their children, they can still identify 2 to 3 career options for their children and figure out the current costs of attaining them. As the cost of attaining higher education can be expected to maintain its steep upward trajectory, they should assume an annual inflation rate of at least 10% for the costliest education option set for their wards. This will help them to be on the safer side while creating the higher education corpus. Once they have a ballpark figure for the required corpus, they should use online SIP calculators to find out the monthly contributions required to create the target corpus.
Determine your asset class exposure
Each asset class has its own distinctive features regarding returns, capital protection, etc. Some asset classes may score high on capital protection and income certainty while some have the potential of generating higher returns at the cost of higher risk.
For example, equities can be very volatile in the short term while generating higher returns than most asset classes over the long term. On the contrary, most fixed income securities offer higher capital protection and income certainty than equities while yielding lower returns than equities over the long term. Thus, parents having higher risk appetite and having at least 7 years left for the start of their children’s higher education should invest in equity funds for creating their children’s education corpus. Those having less than 5 years should opt for fixed income instruments like debt funds, high-yield bank FDs, small saving schemes to ensure capital protection and a certain degree of growth certainty.
Parents planning overseas education for their children should maintain an exposure to international funds. While depreciation in rupee increases the cost of overseas education, depreciating rupee also increases the returns from international funds. Thus, an exposure to international funds would provide a strong hedge to parents creating corpuses for their children’s overseas education.
Begin investing early
Investing early allows you to derive the benefit of power of compounding. With the help from the power of compounding, the gains generated by your investments would start generating returns on their own. This helps in creating a bigger corpus over the long term. For instance, parents aiming to create a higher education corpus of Rs 50 lakh over a period of 21 years would require a monthly investment of about Rs 4,500, assuming an annualised return of 12%. To create the same corpus within 7 years assuming the same rate of return, one would need a monthly investment of about Rs 38,500. Opt for the direct plans while investing through mutual funds as these plans outperform their regular counterparts by a significant margin over the long term.
Opt for the SIP mode
Opting for the SIP mode would help in ensuring regular investment and financial discipline for the parents. Additionally, SIPs also ensure cost averaging by buying more units at lower NAVs during market corrections, thereby eliminating the need for market timing. Investors should also try to increase their SIP contribution in proportion with their income increase. They should also try to top-up their SIPs during the market corrections and bearish market phases when valuations are extremely attractive.
Include the corpus in your term insurance cover
The unfortunate demise of an investor can stop the monthly contributions towards his children’s higher education corpus. The only way to reduce this financial risk is to purchase a life cover equivalent to their targeted higher education corpus. While most life insurance companies offer child plans combining life insurance with investment, parents should instead purchase term insurance cover equaling their target education corpus. Term policies provide larger life covers at much lower premiums while mutual funds offer greater flexibility, higher transparency and more product diversity than child plans. Those having existing term policies can purchase additional term insurance covering the target corpus for their ward’s higher education.
Periodically review your investments
Reviewing the performance of your children’s higher education corpus at periodical intervals is as important as regular investing. As mutual funds with excellent past record can become under-performers for a long time, investors should compare the returns generated by their mutual fund schemes over the past 1-year with their benchmark indices and peer funds at least once in a year. They should redeem their existing fund(s) for better performing one if they constantly under-perform over the last 4 quarters. They should also rebalance their portfolio in case of any significant change in their risk appetite.
(An edited version of this article was printed in Financial Express)