The steep increase in demand for higher education has made it challenging for many families to send their children to their choice of college. Parents often try to avoid this situation by borrowing an education loan for financing their child’s higher education. However, the flip side of this option is that children may have to begin repaying the loan as soon as they start working. One way to avoid this scenario is by steadily building a financial corpus to meet the children’s higher education.
Let’s look at step by step process of building your ward’s higher education corpus:
Estimate your target corpus
While it may be difficult for parents to know their child’s career choices, it may help to assume 2 or 3 career options and estimate the amount currently required to achieve them. As the expense for higher education has witnessed steep inflation over the past two decades and may continue in the near future, make sure to inflate the costliest higher education choice by assuming a 10% annual inflation rate.
Once you are aware of the required corpus, take the help of an online SIP calculator to figure out the monthly contribution required to create the target corpus. Invest in fixed income instruments or debt funds if you have less than 5 years to achieve your target corpus as equities can be very volatile in the short term and fixed income instruments offer higher capital protection and certainty of returns. However, as equities usually beat fixed income instruments by a wide margin over the long term, invest in equity mutual funds if you have more than 5 years to build your child’s higher education corpus.
Start investing early
An early start would allow you to derive most from the power of compounding. It essentially allows gain from your investments to generate returns on their own, growing into a bigger corpus over the long term. For example, if you are aiming to create a corpus of Rs 20 lakh over a 15-year period, you will need to invest Rs 4,003 per month at an assumed annualized return of 12%. To build the same corpus within 7 years at the same rate of returns, he will need to make a much higher monthly contribution of Rs 15,305. Thus, starting early would allow you to build a large corpus with smaller contributions.
Choose the SIP mode of investment
Choosing the SIP mode of investment instils financial discipline by ensuring regular investment. It also helps ensure cost averaging by purchasing more units at reduced NAVs during market corrections. This removes the need for market timing. Always try to increase your SIP contribution in line with your income growth. Also try to top up your SIPs during bearish markets and steep market corrections so that you can purchase more units at lower NAVs.
Opt for the direct plans of mutual funds
Direct plans of mutual funds have lower expense ratio than their regular counterparts. Expense ratio is the proportion of the fund’s average daily net assets utilized for meeting their annual operating costs like advertising expenses, distributor’s commission, fund management expenses, etc. As direct plans do not incur any distribution expenses, their operating expenses are at least 1% lower than regular plans. Lower expense ratio of direct plans lead them to generate higher returns as their savings in distribution expense remain invested in mutual fund schemes, which begin to generate returns on their own. While the difference in their returns may appear to be meagre in the initial years, it can grow into substantial amounts in the long term due to the power of compounding.
Ensure to include the corpus in your term insurance
Untimely demise can put a halt to regular investments for your ward’s education corpus, thereby reducing their chance of attaining higher education. You must always factor in the target corpus of your ward’s higher education while calculating your insurance cover. Buy a term policy to cover the higher education costs as it provides large life covers for a very low premium. Those already having a term policy but yet to start investing for their child’s higher education corpus should buy an additional term policy equalling the target corpus of their child’s education.
Periodical review of your investments
Reviewing your funds’ performance at periodical intervals is as important as regular investing as mutual funds with outstanding past history can become underperformers for a long time. Thus, comparing the returns generated by your mutual fund schemes over the past 1 year with their benchmark indices and peer funds is crucial. Switch to better performing schemes if your existing funds have constantly underperformed their peer funds and benchmark indices over the last 3 years.
(By Gaurav Aggarwal, Director & Business Head, Unsecured Loans, Paisabazaar.com)