Investment schemes for children -- Treat `em with kid-glove

Aarati Krishnan

IF you are an active investor with more than an inkling of how the stock and debt markets function, you might find some features of the various readymade ``children's investment schemes'' constricting. A straitjacketed asset allocation and a long lock-in period are two key failings most of these plans suffer from. An investor capable of monitoring and reviewing frequently his investment portfolio can, thus, work towards structuring his own investment plan to finance his children's education.

A helping hand from personal finance Web sites

Once you have decided to the take the plunge, sites such as iciciconnect.com, kotharipioneer.com and prucici.com offer investment tools that, at the click of the mouse, help you calculate the future value and present value and the annual savings required to accumulate a lumpsum. So, once you have a rough estimate of your target amount and the monthly savings potential, it is fairly easy to know if your savings will be sufficient to meet the target.

Here is a step-by-step guide on how to go about the exercise of saving for your child's education:

Set a target: Planning is much easier when you have a specific amount in mind. You may not know exactly what career your child may choose to pursue in his/her teens, but you can estimate roughly the cost of a professional degree. When estimating the target amount, factor in the impact of inflation. For instance, a professional degree that costs Rs 10 lakh today, will cost Rs 38.69 lakh 20 years from now, assuming the inflation adds just 7 per cent to your bill each year.

Estimate your savings potential: Make note of what you hope to set aside per month based on your present disposable income and expenses. Take into account the expected annual accretion to your salary and the impact of inflation on your savings. While the former will leave you with a larger disposable income, the latter will shrink it. Also decide if you want to invest in instalments spread over a period of time or in a one-time lumpsum. And decide if you would like to step up your investment's size over time.

Estimate your investment tenure: An early start is a big advantage when it comes to investing. It is important to know how many years are left and how much you have to save to achieve your goal. For instance, to accumulate the future equivalent of Rs 10 lakh over a 10-year period (assuming an investment return of 10 per cent and an inflation of 7 per cent), you would have to set aside Rs 8,337 per month, starting now. But start early and save over a 20-year period, and you would have to set aside just Rs 5,096 per month to accumulate the same sum.

There are also other advantages to starting early. Since the monthly savings is a constant figure, and your salary is not, starting early will leave you with a larger surplus in the later years.

Gauge your appetite for risk: How you distribute your investments between different investment options will depend on your own tolerance for risk. Your risk tolerance, in turn, depends on various factors such as age, job security, the rate of increase in your salary, and finally your psychological preferences.

Help is at hand from personal finance and mutual fund Web sites. Kothari Pioneer's Wealth Builder, Prudential ICICI's pruplanner and Icicimoneymanager's Risk Analyser are some of investment tools offered by their Web sites to help you gauge your own risk profile.

Determine your asset allocation: The manner in which you choose to distribute your investments between various options is probably the most important investment decision you will make while meeting your financial goals. Your asset allocation pattern depends mainly on your risk preferences and present age.

Whatever your risk profile, you should consider having a small portion of your money in equities. With the declining interest rates on most fixed income options, you would need equities in your portfolio to beat inflation and provide a ``kicker'' to the returns.

Building the portfolio: If you are of an aggressive bent of mind, consider having 50-60 per cent of your investments in equities. Those in the 20-40 year age group can consider allocating a larger portion of their savings towards equities -- say, 60 per cent. For those in the 40-50 years group, the proportion of equities may be brought down to 55 per cent, falling further to 50 per cent after you become 50 years old.

For those who seek a more balanced approach, equity exposures may vary from 30-50 per cent depending on the age factor, with the balance in debt. Risk-averse investors may choose to put 10-30 per cent in equities, investing the balance in debt instruments.

The choices: When it comes to saving, three investment avenues present themselves -- equities (directly or through mutual funds which invest in equities), debt (fixed deposits with companies/banks, small savings schemes, bonds from financial institutions, debt funds), liquid and money markets for liquidity. Those who are sure they would not be pulling out their money until their child requires it, can avoid the last category altogether. Routing an equity or debt investment through a mutual fund would provide enough by way of liquidity, in the event of an emergency.

A plain vanilla balanced mutual fund (not branded as a children's scheme) may be a good option for an investor who does not wish to rebalance his investment from time to time, depending on the appreciation or depreciation in the value of his investment. However, few balanced funds in the Indian context have tended to stick diligently to a pre-determined asset mix. Therefore, the investor may be better off allocating his own assets between equities and debt (see box).

Getting down to brass tacks

GIVEN the long-term nature of the investment, it may be better for retail investors to stay away from direct investments in the equity market. It may be better to route all equity investments through a diversified equity fund with a good performance track record over a three-to-four year period. The Kothari Pioneer Bluechip Fund, Zurich India Capital Builder Account, Sundaram Growth Fund and Alliance Equity Fund may meet the criteria.

Investors need to bear a couple of factors in mind while investing in an equity fund. One, those investing in a lumpsum should time investments to relatively low equity market levels. Two, investors should keep track of the fund's performance on a quarterly basis in order to re-evaluate their investment in the event of a deterioration in performance. Three, stay away from funds highly concentrated in a few stocks or sectors. Unless you are good at timing the stock market, you may not make much money in a sectoral fund.

Investing in fixed income

For the debt portion of the investment, invest around half in fixed deposits with companies that have high credit rating, or in a bank's term deposit. These investments would provide a solid bedrock on which to build your lumpsum.

Investors can consider investing a fourth of the debt portion in a debt mutual fund. Debt mutual funds offer a market related return and are more tax-efficient than investments in company/bank fixed deposits. Track record and conservatism are the virtues to look for in a debt fund. Sundaram Bond Saver, Kothari Pioneer Income Builder Account are among those with a consistent track record.

Around 25 per cent of the debt portion may be put in small-savings schemes from the government, for their tax efficiency. But, given the risk of a further cut in interest rates, returns from these instruments may, in the long term, align with those available elsewhere in the market. See if you are comfortable with the lock-in period on most small savings schemes.

Having allocated your investments between equities and debt, monitor the performance of your portfolio on a regular basis. This will not only help you rebalance your portfolio from time to time, but also help you switch investments in the event of unsatisfactory performance.

This is the second in a two-part article on investing for your children. The first part was published on April 22, 2001.