With every passing year education costs have been increasing multi-fold. The prime cause – education inflation! With education inflation increasing at a faster rate than regular inflation, of food and fuel (at 11 % as on Feb 2013, CPI figures), what may seem enough to fund higher education today may actually not be adequate for tomorrow. So how should one go about saving for children’s education at such high inflation?
Mr. Sharma a lawyer has big aspirations for his 5 year old son. Having his own law firm, he wishes his son would take over from him someday in future. A professional degree in law from abroad is what he would want his son to have. Mr. Sharma is aware that professional law courses from premier universities overseas come with a heavy price tag. At such high inflationary pressures, how should Mr. Sharma go about saving for his son’s higher education? His son is currently 5 years old, and would be ready for higher education 15 years hence at age 21.
- Begin early
Just like any other financial planning decision, it is wise to start thinking early in life about children’s higher education. The earlier you begin you stay invested for a longer time across different market cycles, thereby reducing risk on your investment. Money grows exponentially over the years thus helping you beat inflationary pressures. Thus, start early by making regular and disciplined investments.
- Set a time frame for your investment
When would you require the amount? Education expenses generally are required after the child’s 17th year, till completion of post graduation. This would help you decide on your appropriate investment option. The earlier you begin the longer is your investment horizon.
- Making an estimate
It isn’t always easy to arrive at the amount of money required to fund your child’s education. However, we could make a rough estimate on the basis on current cost of higher education and the rate of inflation.
A very basic principal of investment management advocated by many is to plan the future casts at inflated values. Work out an “inflation-adjusted” target amount that would be required for the future.
- Choosing an investment
So which asset class should you invest in? The answer to this lies in your risk profile, available liquidity and other goals and commitments.
- Fixed income securities are safe and are well suited for the risk averse investors. One could opt for the National Savings Certificates (NSC), fixed deposits, fixed maturity plans. Returns may not be very encouraging after adjusting for inflation and taxes.
- Public Provident Fund (PPF) is another safe bet. They cannot be liquidated as easily, as they carry a lock-in in the initial years. An ideal low risk option for the long term.
- Equity: Historically, equities have generated superior returns of 15-20% over the long run. They are high risk investments for the short term investor.
- Insurance-Investment Child Plans: Insurance companies offer specific plans designed to meet the liquidity needs of higher education. From traditional endowment plans to Unit Linked Plans, you get a dual benefit of a life cover, along with an investment option. It lets you build a corpus as well as ensures your child’s education needs are met, in case of your untimely death.
Revisiting Mr. Sharma….
Mr. Sharma is well aware that currently a professional law degree abroad would cost him Rs. 15 lakhs.
- Let us assume the cost of education rises up by 10% each year. At 10% education inflation, the same law course would cost Rs. 62 lakhs after 15 years. This is the rough estimate of what Mr. Sharma needs to save.
- It is imperative Mr. Sharma, begins right away, to reap the benefits of compounding. With every passing year, he will have lesser number of years to invest and reach his target. If Mr. Sharma delays his investment plan to when his son is 10 years old, he will have only 10-11 years more to achieve his goal. He would thus have to invest more to achieve the same target of 62 lakhs.
- Sharma also has to make sure at the time of making investments to consider the effect of inflation on the investments real returns. It is important to invest in an option that would earn a return higher than the inflation rate.
- He should also be adequately covered to ensure his son is able to get the education and career he desires, even in case of his untimely death.
- Considering he has a long term investment horizon of 15 years, he could opt for high risk investment options such as equity oriented funds, that would give him better inflation adjusted real returns.