How to use mutual funds for children’s education planning

The cost of higher education in India has been growing in double digits (in percentage terms) over the last 20 years. The cost of 4 year engineering education (B.Tech/B.E) in the top Government institutes is around Rs 9 – 10 lakhs. In some of the top private institutes, cost of engineering education can be as high as Rs 15 – 20 lakhs. The cost of medical education is similar, if not a little higher. In the next 10 years, applying an inflation rate of 10%, the cost of engineering or medical education may be in Rs 25 – 45 lakhs. MBA from one of the top institutes will cost you around Rs 20 lakhs. 10 years from now, you should be prepared to fork out Rs 50 lakhs for your child’s MBA.

Parents need to plan for children’s education

Over the last 20 – 25 years, with more and more graduates with engineering and / or MBA degrees entering the job market, the competition has been intensifying. Most Indian parents in the middle income or higher income groups have very high aspirations as far as their children’s careers are concerned. Parents need to have a savings and investment plan in place over a sufficiently long period of time in order to meet their children’s education goals.

Saving for children’s education

One of the most important aspects of financial planning is to determine how much money they need to accumulate for their children’s goals. You should always factor inflation in determining your goal. Once you know what your goal is, you can figure out how much you need to save to meet your goal. For example, if you want to create a corpus of Rs 70 lakhs for your child’s graduate and post graduate education, 10 years from now, you need to save and invest around Rs 35,000 per month (assuming 10% annualized return on investment). The importance of an early start in financial planning can never be understated. If you have just 5 years to accumulate the same amount, you need to save more than Rs 90,000 per month.

Mutual Funds are ideal for education planning

Through mutual funds you can get exposure to equity and at the same time, diversify risk associated with investing in individual stocks. You can invest in mutual funds through systematic investment plan(SIP) where you can invest from your regular savings through automatic debit from your bank account on a specified date every month or any other interval. Mutual fund SIPs are the best financial planning instruments for your long term goals.

If you investment Rs 30,000 every month through SIP, you can accumulate a corpus of Rs 65 – 70 lakhs over 10 years, assuming 11 – 12% ROI.

Mutual funds offer a suite of products suitable for different risk appetites and investment needs. For long investment tenures (7 to 10 years or longer), equity funds are ideal instruments for your financial goals. You can invest in large cap, multi-cap, midcap, small cap etc. schemes depending on your risk appetite. For moderate investment tenures, hybrid funds which invest both in equity and fixed income are more suitable for education planning. As you near your goal, you should switch to debt funds so that your goal is not impacted by market movements.

You should also ensure that taxes do not eat a substantial part of the returns on your investment. Equity or equity oriented mutual funds are one of the most tax friendly investments. Long term capital gains (investment holding period of more than 1 year) of up to Rs 1 lakh per year is totally tax free. Long term capital gains in excess of Rs 1 lakh are taxed at only 10%.