Make sure the investments’ maturity matches with the years left to reach your goal
One of your life goals would be to provide college education for your children. But how should you fund the education cost? This question assumes importance because sending your child to college is time-bound; you should have the required amount by the time your child turns 18.
You should create a separate education fund for each of your children. Consider the following before doing this.
First, you should set aside money every month from your current income. The sooner you start saving for your child’s education, the better.
Education cost increases at a faster rate than general inflation. So, you are looking at a considerable cash outflow when your child enters college.
Setting aside money from today when your child is young could significantly reduce the stress on your cash flows when your child turns 18.
Second, routing your savings into appropriate investments is important. The risk you should assume on these investments is a function of the distance to investment horizon.
If the distance to investment horizon is five years or less, invest only in bonds. If the distance to investment is more than that, have an appropriate combination of stocks and bonds.
Third, to reduce the risk of bond investments, map the maturity of your bonds to the year in which your child enters college.
That is, if your child is due to enter college 10 years hence, invest in a 10-year bond.
This way, you can redeem the bond at par value and not worry about how its price will decline due to increase in interest rate.
Specifically, your investments should be in tax-advantaged bonds such as tax-free bonds issued by public sector companies and public provident fund. Consider taxable bank fixed deposits only after exhausting the opportunity to invest in the above tax-advantaged instruments.
Fourth, for your equity investments, go for large-cap (Nifty) or broad-cap (CNX 500) index funds. This will eliminate the risk that you could pick a fund that will underperform the benchmark index.
You should also adopt a glide path to reduce your portfolio’s investment risk. That is, you should reduce your equity investments to not more than 25 per cent of your education portfolio when you are five years from the time your child is due to enter college.
Finally, buy a term insurance policy to cover your mortality risk till your child enters college. This will help your family fund the cost of college education in the event of your untimely demise before your child enters college.
Two factors are worth noting here. One, the insurance policy should only last till your child enters college or thereabouts.
And two, the sum insured should be the inflation-adjusted cost of your child’s college education.
If you fall short
There is no significant advantage in buying child education products currently available in the market; most of them are just generic products with special labels.
Despite all your efforts at efficiently managing your child’s education fund, you could face an investment value gap when your child enters college.
In that event, you should avail of an education loan to bridge the investment value gap. Or, you can transfer an amount equal to the shortfall from your retirement account. This follows the principle we call hierarchically-fungible.
That is, you should be willing to transfer money from your retirement fund to your child’s education fund and not the other way; for education fund has higher priority because it is time-bound and has shorter distance to investment horizon.
(The writer is the founder of Navera Consulting. Feedback may be sent to email@example.com )