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.
INVESTMENTS
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 India�s 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 children�s
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 child�s 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.
LIFE INSURANCE
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.
KEY NEXT STEPS
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 child�s 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
