You have a child. You want the best for her. Or him. (Sometimes both. But let’s stop getting politically correct and just use one gender)
So you want to save for her future. You don’t have any idea when she is born about what it will take. You’re mostly clueless about parenthood, and you have probably figured out that the financials of diapers, doctors, vaccines, toys and nannies are the GDP of a large nation.
And therefore you are going to be mis-sold stupid products by bankers. And because you have no clue, you will buy that product named “child protection plan”. Only slowly do you realize that while the “child” is yours, the “protection” is of their obscene commissions.
How Stupid? Meet One – the ICICI Smart Kid Plan
This is the kind of plan your banker may sell you. Or it might be even worse than this one. But bear with us.
The plan’s brochure says this: Invest Rs. 50,000 per year for your child, and after 15 years you get a wonderful sum of Rs. 12.06 lakh at 8% (if they get that much).
What they don’t tell you, because you’re too busy to do this on excel is this: If you put Rs. 50,000 per year yourself and got 8% a year – the exact same return – you would end up with: Rs. 14,66,214. That’s a good Rs. 2,60,001 higher!
But wait, they’ll confuse you will bull like: Oh, we have insurance also! For the parent. How much is the insurance really? Rs. 5,00,000.
This is too little. We don’t even want this little insurance. A more meaningful number is Rs. 24,00,000 (Rs. 24 lakhs).
If you bought Rs. 24 lakhs of term insurance from the same company (ICICI) you will pay, inclusive of taxes, a sum of Rs. 4,146 per year.
And if you subtracted that amount from the Rs. 50,000 and invested just the rest in this 8% investment, you would still have: Rs. 13,44,636 at the end of 15 years.
Where’s the money going? That bank’s profit margin because it gets juicy commissions. That insurance company too. You might as well buy the bank’s or the insurance company’s shares instead.
So What To Do?
It’s quite simple. Firstly, understand that unless you live in fool’s paradise, Rs. 12 lakh is not going to be anywhere close to enough, to meet your kids’ education needs.
At about 8% inflation and a cost of about Rs. 10 lakhs today, an undergraduate degree will cost you about Rs. 40 lakhs in 18 years.
For studies abroad, multiply a current cost (of say Rs. 20 lakhs) by four for a similar number.
If your child is already older, then you adjust accordingly. How? Say your daughter is 2 years old. Then you want the college education fees when she’s 18. That’s how much? 10 lakhs today = Rs. 34.26 lakhs in 16 years. (10 lakhs * (1+0.08)^16, with 8% inflation)
40 Lakhs Is Too Much!
I can only save Rs. 5,000 per month, how will I even get Rs. 34 lakhs or 40 lakhs?
The answer: It’s not that bad.
Let’s make two assumptions:
- That your savings will go up by, say, 6% a year. (Earnings go up, savings also go up)
- That, in the long term, you can get a return of 12% a year.
Then, if you start with Rs. 5,000 a month today, you will get to Rs. 40 lakhs in sixteen years. (In the sixteenth year from now, you’ll be putting in Rs. 12,000 per month)
And that’s not an expensive way to put your daughter through college!
What about School?
School’s more complex. You have to pay fees each year. You could just save that much every year. So if school costs your Rs. 1,20,000 per year now, you will have to save Rs. 10,000 per month now. And increase this amount by inflation every year.
You could optimize this somewhat. An algorithm to save for a few years (before your child begins school) will reduce the amount required. Let’s say you get safer for school and only get 10% on your investment. Then you can put about Rs. 8,200 every year, increasing by inflation (6%) every year, and you’ll be able to pay the increasing school fee too:
Wait, What About Marriage?
Look, if you educate them, they’ll figure out their own marriage.
No, you still want to pay for their weddings? Okay, so here’s what it will take, similar to college education calculations.
A marriage might cost Rs. 20 lakhs today.
If you think your daughter will marry when she’s 30, and she’s 2 years old today, you are looking at a cost of Rs. 1.28 crores.
Sounds extremely high? It costs just Rs. 3000 per month (increased every year by 6%) to get there. Again, we assume a return of 12% on your money!
So, In Total…
- Rs. 8,200 a month for school
- Rs. 5,000 a month for college
- Rs. 3,000 a month for marriage
Which means, if your child is aged 2, you need about Rs. 16,200 per month saved.
This is how it goes.
And Of Course, Caveats
You might get a higher (or lower) return. Every year will not be a constant return. So your actual “curve” will be different, but will roughly get you there in the long term.
Inflation assumptions will change over years. You’ll have to change this graph to reflect that. Remember, if inflation falls, so will return expectations, and so will required costs in the future.
This post is to help you think about the “Strategy“. Read our series on “Take Control, Invest Actively” posts.
Once you’re clear that this is what you need to save to handle your child’s education and other needs, you have an amount of money you invest per month.
The tactics are simple: Exactly what should you do to get the 12% return you have assumed? The answer may lie in a combination of debt and equity. It may be where you invest in stocks directly with some part, and debt funds with another part of the corpus. The tactics also contain notes for tax optimizations and all sorts of things.
You might even decide that the Sukanya Samruddhi scheme is enough for you – you’ll need to invest a higher amount since that scheme offers 8.4% per year today. If that falls, you will need to keep increasing the amount you invest per month. To invest in the scheme is a tactical choice.
Just that is enough to take you there, but you will need to course-correct if assumptions change.
This post will not give you advice. This post is only designed to make you think. At Capitalmind, we help you do it yourself. We hope this is of help.