One of the most important expenses of the average middle class Indian family – Child’s Education; is increasing at a rapid pace. No matter where the current inflation levels are, higher education is increasing by about 10 to 12 percent annually.
Currently, the cost of an engineering 4-year degree course is approximately around INR 6 lakhs. In about half a decade, the cost will nearly double to 10 to 12 lakhs. In ten years, families will need to shell out a princely sum of INR 24 lakhs for getting a degree in engineering.
In the times gone by, education was more or less easier due to low completion and modest fee charged by Government or Government aided education institutions. The currently scenario is a lot different; increased competition for entry into high quality Government institutions has resulted in students opting for private educational institutions which are really expensive! Global brands in the education sector are likely to invest and set up their institutions in India in the future and their tuition fees are going to be very costly.
Education has also been affected by lifestyle inflation. With a growth in the standard of living, parents will take a step towards revising their options of where they need to send their kids for higher education. It is a known fact that children who have been raised in a more affluent society are usually apprehensive and averse towards attending Government institutions which have minimal facilities and infrastructure.
Irrespective of the above listed factors, the major question that keeps the parents awake at night is about the affordability of good higher education for their children and how will they be able to fund it! The answer is that it is possible to pay for costly higher education, provided if parents take the correct steps, strategize, and plan for the future.
Presented below is a discussion on the different challenges that parents may come across when trying to save for the higher education of their children and the different ways in which such challenges can be overcome.
Start saving early
One way to overcome the challenge of paying for expensive higher education is by getting a head-start on the process of saving. You may not be able to save large sums of money, year on year, but the money that you save will become a lot more due to the power of compound interest. Saving up to a lump sum of INR 1 crore may seem intimidating, but parents can save this large sum via an SIP of INR 9,000 for a period of 18 years in an equity-based or equity fund which provides an annual return of 15 percent.
The excessively high rate of inflation in education field means that compound interest for a long period of time becomes a necessity. You may begin saving a corpus fund for your child, when he/she is only a few months old.
If the start is delayed then it will not only result in smaller lump sum savings but can also be detrimental to other financial plans and goals. Individuals who begin saving for their kids’ education when they are in their forties, then they are most likely to not meet the required target amount. In such cases, parents will have to withdraw from their retirement savings to fund the rest; doing so can often be fraught with risks. Parents cannot be all trusting of their children.
Using your retirement savings for educating your child does not guarantee that your child/children will take care of you in your old age.
It is also important to remember that the nature of job and employment prospects is ever changing in today’s globalized economy. Workers and executives across the world get dropped from the workforce when they are only 40 or 50 years old. They are then replaced by younger employees who have more advanced skill sets, more energy, can worker extra hours, and are ok with less pay. This is also one of the reasons why parents need to start saving early for higher education of their children.
Select the correct option
Beginning the process of saving for higher education is not sufficient on its own. It is important to make the right investments for optimal returns.
There are many parents who begin the process even before their children are born. However, in most cases, such savings are often invested in conventional life insurance policies which provide very low 5 to 6 percent annual returns. These policies do offer assured yields and tax savings, but they are very far away from the returns provided by other kinds of investments, now and in the past. For example, equity and equity-linked mutual funds have on average offered yields of 16.5 percent per year over the last decade.
Investment in equity does come with high to very high returns potential. However, not everybody can handle it. Different surveys have shown that Indians in general do tend to increasingly save and invest, but safety of their savings is most important. And more than fifty percent of responders to the surveys indicated that ‘guaranteed returns’ on their investments was an utmost priority.
Experts however state that parents who have 10 to 15 years remaining before their child begins higher education, need to opt for equity mutual funds. This is because the volatility associated with mutual funds typically hits a plateau or gets flattened out over a long period.
Individuals who are ok with increased risks and have time horizon of more than 5 years can opt for funds with nearly 75 percent investments in equities. Increased allocation to equity, and subsequently higher yields, is necessary to offset the burden imposed by the high education inflation rate. Parents who have a long term investment goal of 7 to 10 years and beyond should invest in diversified equity mutual funds.
The remaining 25 to 30 percent of your savings and investment portfolio can comprise of safer and surer options such as bank deposits, PPF, and tax-free instruments and bonds. It may be noted that bank deposits are tax-inept. Hence individuals who fall under the 30 percent taxable income bracket should opt for debt funds. This means that you will not get taxed on the interest earned every year, but will need to pay taxes only when withdrawing. Even in such cases, the tax rate while withdrawing is lower and investors will also receive indexation benefit.
Indexation benefit associated with use of debt funds in longer can help significantly decrease the tax burden.
Keep it safe and plan short term investments
Individuals who do not have 15 to 18 years time to save, but rather less than 5 years, will need to mainly rely on instruments that offer fixed income. These may most probably offer a lower return rate, but you can be assured of guaranteed yields and safety of invested capital. Capital safety and guaranteed returns are really important when it comes to short term investments.
Fixed income funds are quite safe, but you should not invest haphazardly. You need to ensure that liquidity is not going to become a problem while investing in debt securities. For example, PPF is a really good option of investment, but you should not go for it if money is required in 3 or 4 years. The returns offered by tax-free bonds may be quite appealing for investors, but such bonds often come with reinvestment risk. The interest is paid out each year by such bonds and in situations with a falling rate of interest, reinvestment will occur at a lower interest rate. It is therefore important to select the option of cumulative payment.
Check the portfolio
After you have selected the different components of the portfolio, it needs to be reviewed at least once every year. It is also important to verify if the lump sum that is needed to achieve your goals has changed or not. The goal of higher education is divided into two parts, i.e., the cost of living and tuition fee. It is possible for any of these costs to increase more than you projected. It is important to check whether the speculated spike in inflation rate becomes a reality or not.
You may then proceed to verify if the portfolio is actually helping you achieve the goal. You can create an Excel worksheet to estimate the worth of your portfolio at the end of each financial/normal year. Keep an eye on the portfolio and monitor it. In case the portfolio falls behind on meeting the set goals, then you may have to invest more. In such scenarios step-up SIPs are a more appropriate choice. You can increase the invested amount according to the increments in your salary.
It is important to also verify the performance of the portfolio’s varied funds when carrying out the annual review. If some fund is underperforming, then immediately selling it is not the right choice. The correct thing to do would be to stop the SIP in that specific fund and begin it in some other fund which has better performance. Monitor the performance of the underperforming fund for the next 3 to 4 quarters; if it is still lagging, then you may sell it.
It is vital for investors to understand the cause of the under performance before making a decision to sell the fund. This is because sometimes the mandate of the fund may be the reason for under performance in comparison to its peers. For example, a fund comprising of only large caps may adhere to its mandate and avoid mid-cap stock exposure in a market that is rising. It is natural for such a fund to trail its competition that has opted for mid-caps exposure. It is incorrect to dump a fund which observes its mandate.
Last but not the least, the portfolio must be rebalanced by investors after every year. This means that you need to sell an asset that is outperforming and use that money to invest in an underperforming asset. This will help reduce the risk associated with the portfolio due to increased exposure to one specific asset type.
For example, if you begin the year with a portfolio consisting of 75 percent equity exposure and 25 percent debt investment, then in a year which sees the market rise, this equation can get disturbed. The Sensex increased by nearly 30 percent in the year 2014. In such a year, the equity weightage in the fund portfolio will increase to more than 75 percent. Hence, some stocks need to be sold to reduce the exposure to equities and bring it back to 75 percent, and subsequently use the proceeds of the sale to increase the investment in debt.
Steps to take when nearing the goal
The process of investment is never stagnant or static, particularly when the investments are for a long duration. Equity funds are ideal for those investors who are looking to invest for more than 5-7 years and beyond. However, when you are about 5 years away from reaching the goal, then you need to begin moving the money out of investment in equities into the safety and surety of debt. Commence a systematic transfer strategy from an equity based fund to a short-term bond or debt fund with an average maturity of about 1 to 3 years. It is especially vital to invest conservatively when saving for an important goal which cannot be rescheduled or postponed.
It is important to remember that the college admission date of your child is and will remain fixed. Parents should not risk the higher education prospects of their child by any kind of downturn in the equity or stock markets!