Saturday, December 8, 2012

How to secure your child's future?

How to secure your child's future?
On at least one aspect, I think several of the insurance company advertisements have got it spot on. The initial celebrations on the arrival of the child gradually leads to a more sober reflection on how best to ensure his / her comfortable upbringing and education. Doubtless, finances are but one aspect of this concern; but they are an important one! Moreover, they are probably much easier addressed than some of the softer and other cultural aspects of parenting.


Investment is distinct from Savings
Savings simply mean you set aside a portion of your income for future use. Yet, it is (careful and planned) investing that makes maximum use of these savings and optimizes your portfolio in later years. This is especially important since inflation tends to erode the purchasing power of money over a period of time. A headline inflation of 6%-7%, actually translates into a lifestyle inflation of 10%. Thus, if your money is lying in a deposit fetching 7% interest rate, you are actually eroding wealth!

India is the best growth story to invest in
In contrast, with the medium to long-term prospects of Indias growth being as strong as they are, the long-term returns on equity can be assumed to be 15%. Thus, this provides an effective way to not get left behind the growth story that is India. In addition, investing in equity as an asset class, if well researched and carefully done, enjoys various benefits, such as:

    High liquidity, to withdraw money in desired quantity whenever needed
    High flexibility in terms of investing as and when funds are available
    Favourable tax treatment (especially compared to real estate and fixed deposits)
    Low transaction costs
    High degree of transparency in knowing how your corpus grows

The power of compounding
Returns on investments exhibit the effect of compounding. Very simply put, it means that the returns earned on the investment in the first year, gets added to the corpus in subsequent years and fetches its own returns. Thus, in the illustrative returns shown above, if you invest Rs. 1 crore today in equity @15%, the corpus would grow to Rs 4 crore in 10 years time. In contrast, in a fixed deposit @7%, the corpus would only be Rs 2 crore in 10 years time.

Index investing
Investing in the index is possibly the best long-term way to benefit from the India growth story. You can invest in the index either one-time, or systematically as you earn more, or a combination of these. The benefit of index investing is the low transaction cost and low need for research involved. Thus, for those not very comfortable with the markets, or with those having no time to do extensive research, it is also a good starting point to gain familiarity with the working of equity markets.

Once you are more comfortable with equity markets and with how an investment portfolio works, you can consider allocating funds to more actively managed portfolios as well. These require much more research and active management, but at the same time have the potential to generate higher returns than the index by leveraging existing market conditions.

Trust formation
Very often we come across customers desirous of making a trust in each of their childrens names. In India, unlike in some other countries, such trusts by themselves have no special tax benefits. Yet, they often have softer benefits such as helping mentally allocate resources for each childs milestones, monitor each set of investments clearly, etc. Given the formalities and procedures around trust formation, maintenance and reporting, we would recommend this to people having a large corpus only. With most others, the money may be managed through mental accounting alone, without going through the legal procedures around trust creation.

The concept of life insurance is to secure the lifestyle and indeed the financial well being of the family in the unfortunate event of the breadwinner not being around. Due to cultural reasons, this often brings unpleasant thoughts, and hence the subject of insurance gets pushed under the carpet.

However, we would rather look at it as a means to lead a more secure and worry-free life. While the emotional trauma of loss of a family member is unavoidable, insurance atleast spares the financial burden that this could bring. Thus, an insurance of five to seven times annual earnings is a useful benchmark to have as amount of life insurance.

A term plan is a simple and effective life insurance policy. Very roughly, the annual premium for a healthy 35-year old, for a life cover of Rs. 1 crore, should amount to about Rs. 45,000. There are two important points to note here: the earlier you start the life cover, the lower the premium rate you can lock-in (once locked-in, the premium does not ever change). Secondly, it is a huge benefit to start life insurance when one is healthy and unaffected by any chronic ailments. This ensures much lower premiums, and a hassle-free claims process.

We would, at this stage, advise against the more complicated unit linked products; or the typically low yielding traditional insurance products. These are useful for investors only in very specific cases, and only when the investors have understood the cost-benefit equations of these plans very carefully. The insurance agents very seldom do such elucidation; and hence it may be useful to stay away from these for a while.


Just as it is impossible to learn swimming without jumping into the pool, we believe a start has to be made sometime along both these dimensions. And there is no better time than today!

Thus, we would recommend a simple starting point for parents thinking about their childs future:

Invest a lump sum in an index fund, and plan to systematically build this through authorising smaller additional investments monthly. You can look at research to see which are the good funds, and keep your portfolio under periodic monitoring.
Insure your life, for atleast five times your annual earnings. Again, a simple shopping expedition should get you the best term insurance cover applicable for your age and health.

- Ramganesh Iyer

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