Baby steps towards financial planning

Published in Mint on Feb 16 2015

 

Do you remember the feeling that you had when you first held your child in your arms? Some say it was happiness, others say it was responsibility. A part of this sense of responsibility is to provide everything to the bundle of joy. According to a study conducted by Principal Retirement Advisors, children’s education and marriage was the top most financial goal (68%) across age groups of respondents, followed by buying a house (57%).

Mint spoke to some soon-to-be parents and new parents to understand how they plan their finances to meet their children’s needs, including day-to-day expenses, education and marriage. Here is what we found, along with suggestions on what to do to meet these financial goals.

In good faith

Most parents depend on existing income for the day-to-day expenses. Mumbai-based Prianka Singh, 34, a stay-at-home mother to four-year-old Eva, and expecting her second child in two months, said, “We all know that there will be immediate financial needs such as medical care and other expenses when you are going to have a baby. We are dependent on my husband’s current income for these.” However, for the long-term needs such as education, she prefers to invest in equity.

While Singh’s choice of investment is equity, many parents choose to invest heavily in fixed deposits, insurance products and physical gold for long-term needs. Dubai-based Sreeja V. Ramachandran, a 30-year-old homemaker and mother to four-year-old Dakshina, is one of them.

“We have an insurance policy and a couple of fixed deposits to meet the education needs of our child. I also invest in the form of physical gold coins every year for my daughter. These gold coins are for the marriage kitty,” said Ramachandran.

Then there are those who invest only in real estate. “I have a daughter and a son. I only invest in real estate. So far, I have bought three plots near my house,” said Thrissur-based Jayan Raman, 45, who works with Kerala State Electricity Board Ltd. His daughter Archa is 5 years old and son Aromal is 6 years old. When asked why he invested in real estate, he said, “Frankly, I don’t understand financial products such as equity. My father used to invest in land and the value of the property he bought has appreciated. I hope that the plot I have bought will also appreciate in value.”

Parents try their best to provide for their children, even if they need to compromise in other areas. The blame for the trend can partly be attributed to peer pressure.

“Many parents today are making choices that are steadily ratcheting up the amounts they spend on their children, be it for education or leisure. They are also losing sight of what is going on and are constantly trying to push their purchasing power,” said Chandni Parekh, a Mumbai-based social psychologist.

She cited an example to support the argument about how parents are willing to go to extremes for their children. “A 27-year-old father I know was considering selling his 3-bedroom-hall-kitchen apartment in Mulund, Mumbai, so that he could enrol his four-year-old daughter in an international school. Many parents are feeling great pressure and an unnecessary sense of inadequacy,” said Parekh.

Matter of readiness

You won’t have to sell your house or dip into your retirement kitty if you have a plan in place. It is true that children bring us immense joy. And it is also true that a child brings responsibility, for 20 or 25 years or till she becomes financially independent.

So, the first question is: where do you start? Let’s take a step-by-step approach based on the age of the child. “The best time to start investing for your child’s needs is when you start thinking about a family. The plan is to build a ladder for your child gradually,” said Suresh Sadagopan, a Mumbai-based financial planner.

Security: The next step is to create security for your child so that her needs are taken care of even if you are not around to do so yourself.

“If you have no financial plan in place, begin with an insurance cover for yourself. Go only for a term plan. The sum assured of your term plan should be at least 10 times your annual income. Many people make the mistake of looking at traditional insurance plans as an investment vehicle. Remember that traditional plans give an average return of 2-5%, which is much lesser than inflation,” said Kapil Mehta, managing director, SecureNow Insurance Broker Pvt. Ltd. “Don’t mix investment with insurance. If you already have a term cover, check if it is adequate and upgrade accordingly if needed. Always remember that insurance is to take care of your child’s needs when you are unable to do so,” added Mehta.

After life insurance, the next item to tackle is adequate medical cover. “Take a family floater health insurance policy and include the child in it. Generally, children don’t get serious ailments. However, since the premium is low, you should opt for it,” said Rahul Aggarwal, chief executive officer, Optima Insurance Brokers Pvt. Ltd.

Long-term expenses: Next, you should understand that your child will have both short-term and long-term expenses. In the first year after a child’s birth, parents tend to receive many cash gifts. Instead of spending away that money, open a savings account and start investing.

“You should understand that you will need money for the next 25 years. Take a long-term approach and start investing in equity in any form. If you are comfortable with direct equity, then go for it, or you could instead choose equity mutual funds,” said Sadagopan.

In your asset allocation, you should have at least 70-80% in equity. However, if you have a low risk appetite, then you can have a moderate equity exposure of 50-60% in your overall portfolio.

Apart from this, you should also invest in risk-free lock-in products such as Public Provident Fund for your child’s long-term needs. Like Ramachandran, many Indians choose to invest in physical gold for goals such as marriage. “If you have an inclination to buy gold, look at it only as a diversifier of risk since it doesn’t have any co-relation with debt or equity. People stick to gold because they think it is easy to understand. Remember that gold has not been able to beat equity in terms of returns in the long-term. It is a fallacy that gold gives good returns,” said Sadagopan. But if you want to invest in gold, go for gold exchange-traded funds (ETFs) instead of physical gold as the expenses of investing in ETFs are lower compared with investing in physical gold.

Starting investments has to be followed by regular checks of the portfolio. When it comes to long-term investment, to ensure that you are on the right track, revisit your investments and recalibrate as and when required.

Short-term expenses: Now-a-days, higher education and marriage are not the only big-ticket expenses that your child will have. Expensive short-term needs may also pop up—coaching classes for sports such as golf, tennis, football, or any other, tuition classes, vacations or any other form of extracurricular activities.

To be ready for such needs, investments should be such that you can liquidate them easily. “For unexpected or short-term needs, look at products such as debt funds or fixed deposits. The latter work for those who are in the lowest tax bracket. Debt funds on average have given better post-tax returns than fixed deposits,” said Sadagopan. Many parents make the mistake of investing only in FDs without factoring in tax. Before buying FDs, know how your tax slab will affect FD returns.

Like Singh, for the day-to-day expenses you can rely on your current income flow. You can use debt funds for your child’s annual education expenses too.

Steps to implement

Take a year-to-year approach. When it comes to long-term goals such as higher education, invest in equity-related products. This is because equity delivers the best results over a long period. But do remember to gradually move your equity investments to debt as you near the goal, say, a year or two before. Always have some products in your kitty that you can liquidate easily.

Always remember that planning for your child’s future is only one of the goals of your overall financial plan.

While you take care of your child’s needs, don’t neglect your own goals such as retirement. You don’t want to be unprepared for it.

The best tool at your disposal when it comes to planning for your child is simple to be prepared. Read more about this in our children’s special package.

 

 

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