Funding Education for your kids with Mutual Funds

 

Funding Education for Your Kids with Mutual Funds: A Comprehensive Guide for Indian Parents

As parents, one of our most significant responsibilities is to ensure that our children receive the best education possible. However, the cost of education in India has been rising steadily over the years. According to a report by the National Sample Survey Office (NSSO), the average annual cost of general education has increased by a whopping 175% over the last decade. With this in mind, it’s crucial to plan and save effectively to meet these expenses. Mutual funds offer a strategic way to build a corpus for your child's education, providing flexibility, potential for higher returns, and tax efficiency.

In this blog, we will delve into how you can leverage mutual funds to fund your child’s education, the types of mutual funds suitable for this purpose, the power of compounding, and how to build a robust investment plan.

Understanding the Cost of Education in India

Before we explore how mutual funds can help, it's essential to understand the current and projected costs of education in India. Here's a snapshot of the costs associated with various levels of education:

1. Primary and Secondary Education: The average annual cost of schooling, including tuition fees, books, and other expenses, can range from INR 30,000 to INR 1,50,000 depending on the type of school (public vs. private).
2. Undergraduate Education: A three-year undergraduate degree in a reputable college can cost anywhere between INR 5,00,000 to INR 15,00,000. Professional courses like engineering or medicine can cost significantly higher, ranging from INR 10,00,000 to INR 25,00,000.
3. Postgraduate Education: A two-year MBA program from a top-tier institution in India can cost between INR 15,00,000 to INR 30,00,000. For those considering studying abroad, the costs can escalate to INR 50,00,000 or more, including living expenses.

Given these figures, it's clear that funding your child's education requires meticulous planning and a substantial financial corpus. This is where mutual funds come into play.

Why Choose Mutual Funds for Funding Education?

1. Potential for Higher Returns

Mutual funds, especially equity mutual funds, have the potential to offer higher returns compared to traditional savings instruments like fixed deposits or recurring deposits. Over the long term, equity mutual funds have historically provided average annual returns of 12-15%. This can significantly outpace the rate of inflation in education costs.

2. Power of Compounding

Investing in mutual funds early allows you to take advantage of the power of compounding. Compounding is the process where the returns earned on your investment are reinvested to generate additional returns. The longer your investment horizon, the more powerful the effect of compounding.

For instance, if you start investing INR 10,000 per month in an equity mutual fund that offers an annual return of 12%, in 15 years, you could accumulate approximately INR 50 lakhs. This is the magic of compounding, which works best with a long-term investment horizon.

3. Diversification

Mutual funds invest in a diversified portfolio of assets, which reduces the risk associated with investing in individual stocks or bonds. This diversification helps in managing risk and provides a more stable return over time.

4. Systematic Investment Plan (SIP)

Mutual funds offer the facility of Systematic Investment Plans (SIPs), which allow you to invest a fixed amount regularly (monthly, quarterly, etc.). SIPs inculcate a disciplined savings habit and take advantage of rupee cost averaging, where you buy more units when prices are low and fewer units when prices are high, thus averaging out the cost.

5. Tax Efficiency

Certain mutual funds offer tax benefits under Section 80C of the Income Tax Act. Equity-Linked Savings Schemes (ELSS) allow you to claim a deduction of up to INR 1,50,000 in a financial year. Moreover, long-term capital gains (LTCG) from equity mutual funds are tax-free up to INR 1,00,000 per annum.

Types of Mutual Funds Suitable for Education Planning

1. Equity Mutual Funds

Equity mutual funds invest in stocks of companies across various sectors. They are suitable for long-term goals like funding your child's higher education due to their potential for high returns. Within equity funds, you can choose from large-cap, mid-cap, and small-cap funds based on your risk appetite and investment horizon.

2. Hybrid Mutual Funds

Hybrid funds invest in a mix of equities and debt instruments, providing a balance between risk and return. These funds are ideal for parents who seek moderate returns with lower risk compared to pure equity funds. Hybrid funds include balanced funds, aggressive hybrid funds, and conservative hybrid funds.

3. Debt Mutual Funds

Debt mutual funds invest in fixed-income securities like bonds, government securities, and corporate debt. These funds are suitable for parents with a low-risk appetite or those who are closer to their investment goal and want to preserve capital. Debt funds provide more stable returns compared to equity funds but generally lower returns.

4. Equity-Linked Savings Schemes (ELSS)

ELSS funds are equity mutual funds that offer tax benefits under Section 80C. They come with a mandatory lock-in period of three years, which encourages long-term investment. ELSS funds are suitable for parents looking to save taxes while investing for their child's education.

Building an Investment Plan

1. Determine the Education Goal

The first step is to determine the amount you will need for your child's education. Consider the current cost of education, factor in inflation (typically 6-8% per annum for education costs), and estimate the future cost.

For example, if the current cost of an engineering degree is INR 15 lakhs, and your child will start college in 15 years, the future cost at an inflation rate of 7% will be approximately INR 41 lakhs.

2. Assess Your Risk Appetite

Your risk appetite depends on your financial situation, investment horizon, and comfort with market fluctuations. For long-term goals (10+ years), you can afford to take higher risks with equity mutual funds. For medium-term goals (5-10 years), a balanced approach with hybrid funds is suitable. For short-term goals (less than 5 years), focus on debt funds to preserve capital.

3. Choose the Right Mutual Funds

Based on your risk appetite and investment horizon, choose the right mix of mutual funds. For a long-term goal like funding your child's higher education, a higher allocation to equity funds is advisable. As you get closer to the goal, gradually shift your investments to debt funds to reduce risk.

4. Start Early and Invest Regularly

Starting early gives you a longer investment horizon and allows you to take advantage of compounding. Use the SIP route to invest regularly, which helps in averaging out market volatility and inculcates a disciplined investment habit.

5. Review and Rebalance Your Portfolio

Regularly review your investment portfolio to ensure it aligns with your goals. Rebalance your portfolio periodically to maintain the desired asset allocation. For instance, if your equity funds have performed well and now constitute a higher percentage of your portfolio, consider shifting some funds to debt to reduce risk.

Case Study: Planning for Your Child's Education

Let's consider a case study to illustrate the process.

Scenario

• Parent's Age: 30 years
• Child's Age: 2 years
• Investment Horizon: 16 years (until the child turns 18)
• Education Goal: INR 50 lakhs (adjusted for inflation)
• Monthly Investment Capacity: INR 10,000

Step-by-Step Plan

1. Determine the Education Goal: The parent needs INR 50 lakhs in 16 years.
2. Choose the Investment Mix: Given the long-term horizon, the parent can allocate 80% to equity mutual funds and 20% to debt mutual funds.
3. Calculate SIP Amount:
• Equity Mutual Funds: INR 8,000 per month
• Debt Mutual Funds: INR 2,000 per month
4. Select Mutual Funds:
• Equity Mutual Funds: Choose a mix of large-cap, mid-cap, and ELSS funds for diversification and tax benefits.
• Debt Mutual Funds: Choose short-term and ultra-short-term debt funds for stability.
5. Start SIP and Monitor:
• Invest INR 8,000 per month in equity mutual funds.
• Invest INR 2,000 per month in debt mutual funds.
• Review the portfolio annually and rebalance if necessary.

Expected Outcome

Assuming an average annual return of 12% from equity funds and 6% from debt funds, here's how the investment will grow:

• Equity Funds: INR 8,000 monthly investment growing at 12% annually for 16 years will accumulate to approximately INR 47.5 lakhs.
• Debt Funds: INR 2,000 monthly investment growing at 6% annually for 16 years will accumulate to approximately INR 8.5 lakhs.

Total Corpus: INR 56 lakhs (exceeding the goal of INR 50 lakhs).

Conclusion

Funding your child's education is a significant financial goal that requires careful planning and disciplined investing. Mutual funds provide a flexible and effective way to build the required corpus, offering the potential for higher returns, tax efficiency, and diversification.

By starting early, investing regularly through SIPs, and choosing the right mix of equity and debt funds, you can ensure that you are well-prepared to meet the rising costs of education. Remember, the key to successful education planning