Thursday, March 15, 2012

Planning The Children Future

For mothers, their children's future tends to be an overbearing concern. Mothers want the best for their children and often expressions like 'the best of everything' find place in conversations related to children.

However simply having your heart in the right place isn't sufficient; there is a need to adopt a hands-on approach and ensure that you work towards making a good future available to your children.

The first step in the process is to set goals, that is decide on the various events in your child's life which you would like to be prepared for. The goals could range from providing for children's education, planning for their marriage to accumulating a corpus that can be utilised as seed capital for venturing into a business activity.

The need to plan and invest for the future largely emanates from two factors, i.e. inflation and lifestyle changes.
Inflation deserves to be credited as one of the biggest factors necessitating the entire planning process. In simple words, inflation is a general rise in price levels. As a result it leads to a decline in the purchasing value of money; consequently individuals are required to pay a larger sum of money to purchase the same quantity of goods with passage of time.

Let us take an example to explain the same. Suppose paying for an MBA degree from a reputed institute entails spending $ 30,000 at present. Assuming that your child is 5 years old at present and will be 20 years old when he enters the business school, this gives you a time span of 15 years.

With an inflation rate of 6% per annum and all other factors remaining constant, the fees for the MBA degree would have swollen to over $ 70,000. Quite an eye-opener isn't it?
Another vital factor is changing lifestyle. With incomes on the rise and a higher disposal income available to consumers, there is a perceptible change in tastes and preferences. As consumers move 'up the ladder,' they are increasingly get accustomed to better products and services. This needs to be factored in while planning for events like your child's wedding as well.

The investment advisor
Having discussed the need to set objectives, now let us take a closer look at the process of setting objectives. Firstly there is a need to monetise objectives, i.e. determine how much money you will need to fulfill each of the goals. For retail investors, conducting the entire planning process and performing the complex number crunching can prove a bit too much to handle.

This is where the investment advisor must step in. The advisor should help you determine the total funds required. Further he must structure a portfolio based on your needs and risk profile.

His role doesn't end here; in fact there is a need to closely monitor investments and make necessary adjustments. The investment advisor has a role to play in each of these activities.

The power of compounding
For many the idea of accumulating huge sums of money seems like a daunting task. In fact often this is used as an excuse for not planning at all and leaving finances to chance.

Rest assured, if you refuse to make a plan and adhere to it, there's a high degree of probability that you will never achieve your financial goals. Another misconception is that you need higher savings/investments to achieve your financial goals.

Whether you achieve your financial goals or not is more often a factor of your saving and investment habits. A combination of correct investment advice, proper investments and sufficient time can help you achieve all your goals. An example will help us substantiate this hypothesis.

Mrs Anton and Mrs Smith are friends who share their birthdays as well; both are building a corpus for their future needs. Mrs Anton starts saving $ 1,000 each year at the age of 30 years; on the other hand Mrs Smith starts her savings at the age of 40 (i.e. 10 years after her friend started her savings).
However to make up for the lost time, she invests twice the amount, i.e. $ 2,000 per year. Both of them earn the same returns on their savings i.e. 8% per annum.

The 10-year itch

Mrs.AntonMrs.Smith
Amount invested ($ per annum)    1000    2000
Tenure of investment (years)          20           10
Returns (% per annum)            8            8
Maturity amount ($)  45,762   28,974

At the age of 50 years, their investment kitties would be -- $ 28,974 for Mrs Smith and a whooping $ 45,762 for Mrs.Anton. Despite investing a higher sum, Mrs Smith's investments failed to match those of Mrs Anton. The secret lies in the power of compounding.

Mrs Anton had a head start of 10 years that made all the difference. We have all heard the cliché: 'Time is money'; in the world of investments, time IS money! The key lesson to be learnt -- start early and give your investments sufficient time to grow.

What happens if you don't start early?
For investors who don't have time on their side, achieving their objectives can become a daunting task. It would entail taking on a higher degree of risk (which is never advisable) or setting aside a higher portion of the savings (this may not be feasible if you are fixed income earner). Another alternative would be to simply tone down the objective.

Let us take an example to understand the implications of not starting the investment process well on time. Say you are planning for your 5-year-old daughter's wedding 20 years from now. You have set yourself a time horizon of 20 years and arrived at an expenditure of $ 10,000 at present prices for the wedding.

If the inflation rate is assumed to be 6%, the sum required on maturity is approximately $ 320,000; another assumption is that the investments will yield a return of 12% per annum.Now let's consider 3 scenarios, i.e. the objective has to be met in a span of 20 years, 15 years and 10 years, respectively.

Does time matter?

Case 1
Case 2
Case 3
Target amount ($)
 320,000
 320,000
 320,000
Tenure (years)
            20
            15
            10
Returns (%)
            12
            12
            12
Annual investment ($)
      4,441,2
      8,583,7
    18,234,7
Monthly investment ($)
       351,2
       678,7
      14,41,9

As can be seen in table 2 above, if you have a 20-year horizon, you need to set aside just $ 3,701 on a monthly basis to achieve your target sum of $ 320,000. However with passage of time your investment target stiffens considerably.
A delay of 5 years will entail investing $ 7,153 every month; while starting the investments after a span of 10 years will mean investing $ 15,196 every month.

The investments
Your risk appetite and investment objective should ideally dictate the investments made by you. A wide range of investment avenues can be utilised, these include both assured return schemes and market-linked instruments.

In the small savings segment, schemes like the Public Provident Fund run over a 15-year time frame and can be effectively used to plan for a child's education. Similarly others like National Savings Certificate and Kisan Vikas Patra offer assured returns over a fixed tenure.

Mutual funds (powered by their versatility) should emerge as default choices as well. Some fund houses offer dedicated child plans which attract investments targeted over the long-term horizon. The systematic investment plan (SIP) route must be used as it not only helps you reduce the average cost of investing but is also lighter on the wallet. Furthermore it does away with the need for timing the markets.

Then we have Unit Linked Insurance Plans (ULIPs) dedicated for children; they can play a vital role in building a corpus for children-related needs as well. An ideal portfolio would comprise of instruments from all the above categories in varying proportions.

Finally a word of caution! The corpus meant for your child's future needs will build gradually over a longer period of time; there can be situations when you might be faced with a cash crunch and drawing from your child's portfolio may seem like a logical choice.

Desist from doing so and maintain the sanctity of that portfolio at all times. Remember that any deviations in your child's portfolio can jeapordise your goals and his future as well.



2 comments:

  1. Sir I invested a big amount in single plan now i understood Systematic investment plan. I am going to separate the amount and invest in mutual fund thanks for the information.....

    ReplyDelete
  2. ok, thanks for visited my blog, i hope your plans can run as your expectation

    ReplyDelete

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