On a recent holiday to the US, my husband and I visited our respective alma maters. We were thrilled to walk down the familiar corridors and meet our erudite professors. We benefited tremendously from the experience of studying abroad, but when we graduated more than a decade ago, the fee structures were reasonable. So our jaws dropped when a friend mentioned that he was paying $1,80,000, or nearly Rs 1 crore, to fund his son’s MBA from Columbia University, New York. Nearly half of my friend’s assets would be consumed to fund it, leaving him little for his daughter’s education and his own retirement.
Funding higher education even in India may not be cheap. A four-year undergraduate programme at IIT is about Rs 4 lakh. A two-year PGDBM programme at IIM costs Rs 34 lakh. Hence, an IIT-IIM sixyear programme can set you back by almost Rs 40 lakh. If we factor in 10% education inflation, it will set you back by Rs 1.5 crore 10 years later.
Children’s education is a non-negotiable goal for most parents and can often be the single largest cash outflow. Hence, building the fund for your child’s higher education, whether in India or abroad, definitely needs planning.
Common mistakes while planning for your child’s education
1) Starting late:
The best way to realise the goal without much strain is to start early, ideally when your child is born. In such a case, the investment amount is lesser and the exponential effects of compounding make your wealth grow faster. Unfortunately, by the time many parents wake up to the high cost of education, it is too late. Unmitigated spending and high EMIs tend to wipe away most of the savings in the early years, leaving little for future goals.
2) Underestimating the cost:
This is the most common mistake made while determining how much to accumulate. It is important to come up with a realistic number for the education cost, which includes not just college fees but also accommodation and other living expenses. Then calculate what this education will cost when your child is ready to pursue it. If an Indian postgraduate programme costs Rs 17 lakh today, it will amount to Rs 44 lakh after 10 years, assuming that education cost will increase by 10% each year. Hence, the goal should be to build Rs 44 lakh over 10 years, not Rs 17 lakh.
3) Choosing wrong investment options:
Child education can be funded through various assets, be it mutual funds, fixed deposits, real estate or specialised children’s education plans. The key is to invest and manage these assets efficiently so that they generate adequate returns to meet your goal. Mistakes are made when people have unrealistic expectations about returns and tenure of investment. For example, equity mutual funds should only be used as a means of growing wealth if the investment horizon is five years or more. The long tenure reduces the volatility and risk associated with equity to a large extent, enabling it to deliver returns that beat inflation. Fixed deposits work well for shorter tenures.
It is advisable to invest in FDs or similar debt instruments when the goal is less than five years away. This interest is taxable at marginal rates, reducing the overall returns and impeding its ability to beat inflation. If you must build the education fund using FDs, you should invest a larger amount initially so that the post-tax returns are adequate enough to meet the goal.
If you invest in well-diversified, high-quality equity mutual funds, delivering an annualised return of 10%, you will need to invest Rs 17 lakh today to build a fund of Rs 44 lakh 10 years on. If you invest in a recurring or fixed deposit offering a post-tax return of 6%, you will need to invest Rs 25 lakh over the next 10 years. Similarly, you will have to put in Rs 21 lakh in real estate to build the same fund, assuming a post-tax, annualised return of 8%.
4) Failure to cover risk:
If you are creating a corpus through monthly investments or systematic investment plans, the risk that you may discontinue the investment due to death or disability is very real. In such a scenario, the corpus will only be partially built. Hence, it is important to have a life cover equivalent to the education corpus envisaged. In case of death, the payout can ensure that the child meets his education expenses. Permanent disability, critical illness and waiver of premium on disability are some of the riders that must be attached to life covers for added protection. If you are building the fund through an illiquid asset such as real estate, you run the risk of not being able to liquidate the asset in time and for the value that you expect. You need to ensure that the property is sold a few years before your child starts his education so that the funds are readily available when needed.
5) Disregarding specialised children plans:
Such plans from insurance companies work well when the tenures are 10 years or more. With the restructuring of costs, these plans have become an attractive option. On maturity, they can use the fund value for the child’s education expenses. In case of death during the policy term, the insurer will pay not only the sum assured to the nominee, but also all future premiums till the end of the term. This ensures that the fund does not stop growing and the corpus is available. An RD or SIP in a mutual fund will not cover these risks.
6) Compromising an independent retirement:
Life is all about prioritising. It is not worth planning for an overly expensive education if it compromises your financial independence. If setting aside Rs 1 crore for a foreign education implies that you will be left paying a loan for many years, or will be financially dependent on your child for the rest of your life, don’t do it. Look for other, less expensive alternatives. It is extremely important to secure your financial independence first, before your child’s education needs.
The author is Director, PeakAlpha Investment Services.