Stay away from child plans

Raising children, every parent knows, isn’t easy; ensuring a secure future for them is even more overwhelming. One has to provide for medical expenses, not to mention the ever rising tuition fees. The way inflation is rising, things are only going to get worse.

Understandably, one needs to save. And when trying to save, time is the greatest ally; so the sooner one starts, the more equipped she/he would be to address future expenses.

However, most parents tend to invest in products labelled as ‘children’s plan.’ This is a mistake. Investment products do not come with an ‘Adults Only’ certificate. What this means is that you can use precisely the same investments that you use for yourself for your child. Think PPF, NSC, RBI bonds, mutual funds, post office instruments, and of course, pure equity.

Most ‘child insurance’ products are nothing but modified endowment or money back policies, if not unit linked insurance policy. The change of label, so to speak is a psychological ploy. To use a cliche, changing the name doesn’t change their nature.

These policies suffer from the same limitations that traditional endowment policies suffer from in terms of low returns and high costs. After deducting agent commissions (which are pretty high), mortality premium and other administrative costs, only the remaining money is invested. Also, the bonuses declared are not on a compounded rate basis like, say, the returns of PPF or cumulative RBI savings bonds are.

Nowadays, most such child plans offer insurance in the name of the parent —- which is fine, but compromising on the child’s future is a pretty expensive way to buy insurance. It neither benefits the child nor the parents. If you need insurance, buy term insurance. All the money that you would save on account of the low premium can be invested for the long-term for your child.

Also, what your child needs is capital growth —- as fast as is safely possible. Therefore, nowadays, ULIPs have also started being marketed as child plans. Again, if it is a traditional ULIP or a child plan, it still remains an ULIP.

Understand the expense structure well before committing your funds —- most ULIPs have a very heavy front-end expense structure. And even though insurance companies claim that the expense structure comes down over the years, that is really not the case.

Even mutual funds offer the so-called child plans, which are nothing but liquid or balanced funds with a higher lock-in period. There is no point in investing in such plans except, of course, to lock in your funds. Which brings us to the question — what is a good investment for a child?

One answer is PPF. Yes PPF, an instrument which is generally considered to be “adults only.” Say 20 years from now, you would require Rs 22-25 lakh for your child’s higher education and around Rs 5 lakh for marriage.

A simple yet effective investment strategy to provide for this would be to open a PPF account in your child’s name in the very first year. Invest Rs 70,000 in this account every year. In 20 years, you will have a whopping Rs. 32.03 lakh at your disposal, which can be used for the education and marriage of your child and still have some left over.

No insurance policy can assure you of such a return. Such is the power of compounding and selecting the right plan.

The strategy

Your child is still a child and he or she doesn’t have the capacity to make proper financial decisions. So it is you who must make these on his or her behalf by making optimal use of the instruments at your disposal. It is a prudent practice to invest the funds in your own name, earmarking the capital for the child, as and when he or she may need it in future. This way, you prevent any misuse of the money by misguided immature children.

The only thing you need is discipline to keep the earmarked funds invested over the time that your child attains majority, so that the power of compounding makes the money grow healthily.

The instruments

As mentioned earlier, planning investments for the child does not mean using anything different from what works for you. You can choose a diversified equity fund (not a children’s plan!) with a good track record and allocate a small portion of the money to this fund to be invested systematically over the years.

Historically, equity investments have outperformed all other asset class. However, it comes with associated risks. The key is that the child’s situation in life allows him/her to undertake that risk. Grab this opportunity with both hands. A small sum kept aside, say Rs 3,000 a month, can grow to over Rs 15 lakh at a conservative 12% p.a. in 15 years. To cut the long story short, PPF + diversified equity mutual fund = Your child’s future.

sandeep.shanbhag@gmail.com