More often than not, I am faced with questions from prospective clients like “Can you suggest a good plan for our child?”, “Would this insurance plan be good for our child?” and so on. This makes me ponder as to how do I explain these concerned parents that insurance policies do not make good investment vehicles. And the first question I always ask such parents is, “Would any amount of insurance money compensate the loss of your child, if it so happens”? That is when they realise the futility of their investment in child insurance plans.
The best ways to secure your child’s future would be to have an asset allocation based on the number of years left for his higher education / marriage etc. Considering that the child is only a few years old and that these goals are due only after a period of 10-15 or maybe more years, our advice to our clients would be to allocate their savings in debt and equity in an amount proportionate to their savings and required returns. Let us take an example of a child who is one year old and we need to save for his higher education, we would generally recommend a PPF A/c. in his name and SIP in diversified equity funds. Now how do these work? Let me explain in detail -
PPF A/C. -
A PPF Account may be opened under the name of a minor by his/her legal guardian. However each person is only eligible for only one account under his/her name. So if you open an account with a minor, it is considered to be your PPF Account.
A minimum yearly deposit of Rs. 500/- and a maximum deposit of Rs. 100,000/- can be made in a PPF account in any given financial year. So technically, if you already have a PPF account in your name, and say you are depositing Rs. 100,000/- in your a/c. Every year, you can divide the amount between you and your child’s PPF accounts, but you cannot invest Rs. 100,000/- each in both your accounts.
The interest rate for the PPF account is decided by the government every year and the current interest rate for the year 2013-2014 is 8.70%, compounded annually. Note the minimum tenure of the PPF account is 15 years, which can be further extended in blocks of 5 years each for any number of blocks.
The PPF A/c. currently enjoys the EEE status, i.e., the investment is exempt u/s 80C, the interest is exempt and the withdrawal on maturity is also exempt, making it by far one of the best debt instruments available for investment with low risk and moderate return. Please note that I mentioned ‘moderate return’, since this return would not possibly beat inflation, but it would definitely beat the return generated by an insurance policy.
So if investment in the child’s PPF a/c. is made in a disciplined manner over a period of 15 years, you will have a decent sum accumulated for his higher education when his age is 16 - 18 years.
Diversified Equity Funds -
Diversified equity funds are mutual funds which contain a wide array of securities to reduce the amount of risk in the fund. Having said that, note that investment in any mutual fund is any day a risk taking proposition; however it justifies the risk – return reward if the investment is over a long period of time.
If a parent is not comfortable with the idea of taking huge risks, it is always better to start off SIPs’ in balanced funds and large cap funds to attain a comfort level before moving on to the more diversified funds.
Any investment in mutual funds over a period of one year would enjoy a capital gain which is tax free, making it tax efficient. And historically, the markets have always managed to beat inflation over a long period of time. A classic example of this would be the Franklin Templeton Bluechip Fund where Rs. 10,000/-invested in December 1993 has grown to Rs. 590,972/- in December 2013, despite the market downturns in 2008 and 2011, giving a whopping return of approximately 22.51% compounded over a period of 20 years. An SIP of Rs. 5000/- every month since inception in the same fund has generated a return of 13.16% per annum compounded and would help attain all your goals for your child. No Bank fixed deposit or an insurance policy would have given such kind of returns even in the wildest of our dreams. This is the power of compounding.
And this also shows that a disciplinary approach to investing in select funds over a long period of time would generally help you to attain your goals for your child, even if we take a conservative rate of return at 12%.
It is now needless to say that insurance plans for children are investments of the bygone past. Yet the above recommendations are mine alone and may be contradictory to the views of others.
Happy Investing to your Child’s future!