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  • Financial planning for children no child's play

    Parag Parikh The Times of India, November 8, 2011]

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    All parents seek to provide as much security to their children as they possibly can. That is why financial planning for children is a subject which is close to their heart. I have often come across couples who are keen to save and invest for their child's higher education and marriage right from the month he/she is born. This is a commendable thought indeed.

    However, lofty objectives alone are not enough. In order to attain them we require competent execution too. It is here that many parents fall short. Sometimes age-old beliefs and fears come in the way. At other times, parents fall prey to sharp marketing practices which are potentially detrimental in the long run.

    Here are a few instances:

    Many parents are inordinately concerned about the safety of principal while investing for their children. This could be due to heavy losses that they themselves have suffered due to injudicious investments in the stock market. That is why they will opt for long-term bank fixed deposits, instruments such as Public Provident Fund (PPF) or National Savings Certificates (NSC), debtoriented insurance plans such as Endowment or Money Back.

    However, considering that your investment horizon is often fifteen years or more, such investment options only provide a false sense of security. No doubt your nominal principal may be safe but the returns are not immune to the twin demons of inflation and taxation. Many parents therefore expose themselves to "shortfall risk" as the net returns generated by these 'safe options' often fail to keep pace with inflation (especially education related inflation).

    Some parents go to the other extreme and invest a large sum of money in real estate believing that they will sell it at a hefty profit whenever they need money to fund their child's future requirements. While real estate is a good asset to beat inflation, the associated costs of owning it - whether it is annual maintenance, taxes, insurance premia, etc - are often ignored. Also it is a relatively illiquid investment and one may have to undertake a distress sale at times. Besides, real estate returns often seem impressive when compared on a point-to-point basis but look ordinary on a Compound Annual Growth Rate (CAGR) basis.

    Some parents are overwhelmed by the challenges of investing and prefer to outsource the task to mutual fund schemes and insurance plans aimed specifically at children. However, there is enough empirical evidence to show that such products are mere marketing gimmicks and are no way better than the 'regular schemes' offered by the same institutions.

    So how should one go about it? As in everything else in life, a sense of balance is important. As the goal is usually many years away, it is important that portfolios contain a reasonable percentage of stocks or equity mutual funds as they are the most tax-efficient inflation hedges and their volatility too reduces with the passage of time. This could be supplemented with fixed income options and if the portfolio is very large, real estate too.

    While determining the asset allocation, compare the relative returns, cost, liquidity and tax angles. Also ring-fence this portfolio so that you are not tempted to use this money for other unrelated purposes.

    Finally, it is important that as parents you take adequate life insurance cover for yourself (and not on your child's life as some parents mistakenly do) and also appoint a guardian so that your child does not suffer in case you meet an unfortunate and untimely death.

    If you feel that financial planning for children is not a child's play, it is best you consulted a certified financial planner (CFP).

    The original article could be seen here.

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