How should we save money for our Kid’s future

Most of us, the moment we become parent, start thinking of the future of our child “ Mera Beta (Beti) bada hokar mera naam karega “ is a famous Indian saying.

To make his future bright we do everything so as to give him the best education and organize a stylish wedding and for all this we need money in fact lot of money. Here comes various things in mind; how to build the corpus for these expenses, some of them are:

1. Which instruments are suitable for my requirements?

2. Will these help me to build an adequate corpus for my all goals?

3. Are ULIPS/Child Insurance Plan are right investment option for future goals, or should we take PPF or Sukanya Samriddhi Yojana for my daughter?

4. What about real estate? Is this a good deal, or Gold is better option?

5. Or should I simply put all my money in fixed deposits?

Most of the time people keep on randomly putting their money in various options due to ignorance and/or wrong advice without understanding the long term implications of the same. The common mistakes people do while investing are:

1. Thinking too much about safety then return

2. Inconsistent Investments

3. Not starting early

4. Ignoring their own health

5. Not taking proper life insurance

These mistakes results to in-adequate corpus to fulfil child’s ambitions or then digging out the retirement corpus to compensate the same.

So what is the right way to create sufficient corpus for the child’s future and how should we go for it. Let’s understand this.

1.  Firstly we should know how much amount in current value is required based on his/our ambitions.

2. We need to calculate the future value of the corpus based on the time horizon

3. Based on time horizon we need to decide the right asset allocation for the investments. i.e. how much amount or percentage should be invested in debt, equity, gold, real estate etc.

4. Based on asset allocation we need to decide about the instruments i.e. which company’s equity? Should we invest direct equity or through mutual funds, In debt whether FD or PPF or Sukanaya Samridhi or Debt Funds or Balanced Funds, In Gold should we take physical gold or ETFs? In Real Estate residential or Commercial, and in which City? Etc..

Now let us find out the answers of some of the common questions.

(a) What is the right options for investments?

Mutual Funds could be one of the best option for regular investments through auto pilot mode. We need to construct an optimum portfolio with right mixture of equity and debt based on investors risk appetite and time horizon. For a long-term goal, it is better to have investments inclined towards equity, whereas for short-term goals, have more exposure to debt. Once the scheme/portfolio is finalised we can let the money keep on investing in those funds on regular basis through SIP route. For more details read my previous post the link of which is given below.

 Mutual Funds are not just Right, they are Better also

(b) PPF, FDs, Sukanya Samridhi Yojana (SSY) are Safe and Secure, So should we go for it?

These are debt products which are relatively safe and can be invested if our time horizon and risk appetite demands so. However we should remember that although PPF and SSY but there interest rates also changes every quarter based on the current interest rate scenario and we should not expect very high returns from them. Further PPF is 15 year instrument and SSY is also 10-15 years instrument so we should also keep in mind the future requirements.

(c) What about ULIPS or Child Insurance Plans, how good are they ?

Investment and Insurance are two other things and we should not mix them. All the Child insurance normal endowment plans gives 5-7% returns, while ULIPS are equity debt mix and give market return less of various expenses i.e. morality charges policy admin charges etc. and there will also be GST on the premium amount. We should always remember that It’s not the children who need insurance, but parents. A prudent option is to go for a combination of a term cover and mutual fund investment. For further details read my previous posts Mutual Fund Term Insurance: Best of Both Worlds .

(d) What about Real Estate, is this good investment option?

For last several years real estate has given almost negligible return. Apart from that it is kind of illiquid investment which cannot be sold in short notice in case of urgent The rental yields are 3-5% which are very low and unattractive. Besides, there are various other charges that we need to pay like property tax, maintenance cost, high transactional costs, or capital gains when you sell it. Further a property is not divisible and we cannot sell one room in a flat or a house to meet an immediate expense.”

All those issues makes real estate an un-attractive investment option.

(e) Is Gold better to invest for long term?

Normally we all Indians need gold for our Child’s wedding, but buying physical gold has its own draw backs. One is if we buy gold jewellery it may be outdated by the time our child marries or he/she may not like it. Secondly there are storage expenses and purity issues. 

So what could be the better option to buy gold? The answer is Either ETFs or Sovereign Gold Bonds, further as Sovereign Gold bonds gives interest of 2.5% besides paying back the market price of gold at the time of maturity so this could be better option if we need to buy gold in future.

(f) Should we take Education Loan or dig out form my Retirement Corpus to fund my Child’s Education?

Taking education loan is better option due to following reasons,

·        This keeps our Retirement Corpus safe,

·        Our Cash flow from existing corpus remains intact

·        By taking Education Loan we create sense of discipline and responsibility in the child that he should be sincere on his studies and take up the repayment responsibility

·     Education loans are easily available for good course, both for Indian and foreign higher education.

·      The interest rates start at a low 8-10% and no guarantor or collateral is required for loans below ₹4 lakh.

·        Education Loan has tax benefit also as the entire interest portion of the loan is eligible for deduction under Section 80E of the Income Tax Act.

·        There is grace period of one year, as mandated by the RBI, after the child finishes his education and starts repaying the loan. Hence child will have sufficient time to start repaying the loan

For further details read my post, the link of which is provided below.

Education Loan: An option to enrich your skills even if you can’t afford it right now

As we can see from above points it’s better to take loan rather than digging out from retirement corpus.

Nothing is impossible in this world, If we plan it properly and timely we can achieve great goals and dreams for our kids in a very easy and simple way.

Education Loan: An option to enrich your skills even if you can’t afford it right now

Education loan is an option for those students who want to go for higher studies but are restrained due to financial reasons.  Recently Central government is pushing banks to promote education loan schemes. Further there is increased competition among lenders following the entry of NBFCs into this space, this made education loan easier and cheaper as compared to few years back.

An education loan not only funds our higher studies but also help save tax. Education Loan from recognised banks/NBFCs are eligible income tax benefits under Section 80E of Income Tax Act of India. The interest paid on the education loan can be claimed as deduction, as per Section 80E of the Income Tax Act of India, 1961.  

So how should one go for it?

1. Decide the Course and Institution: 

Just because we are getting loan does not mean we should take admission in any course. The decision for a course should be independent of whether it is financed by a loan or not. This decision should be based on what we want to do in future according to that the institute and course should match our future goals.

2. Determine the Amount

Once the course and institution is finalised then we need to determine the loan amount required. We need to consider other expenses also in addition to tuition fees. Like: hostel charges, mess expenses, other incidental expenses, if going abroad then visa and travelling expenses etc. also. After arriving to the total amount we need to deduct the amount our parents are going to contribute. The figure that is left with will be the loan amount required.

3. Analyse the future repaying capacity

After all this is a loan and we have to repay back from our future earnings. Hence we need to see that whether the future earnings after this course which we are doing will be sufficient enough to repay the loan. For that we need to analyse the job prospects of that course, historical placement details and the salary offered. We should consider the average salary and not the top salary offered to get a realistic income numbers. As a thumb rule our EMI should not be more than 30% of the prospective take home salary.

4. Find out the best deal

After determining the amount of loan based on our future payment capacity, we can check with various banks/NBFCs for the interest rates and other terms & conditions. Banks usually give loans at lower rates for premier institutions like IIMs and IITs as compared to other government or private institutions. Lenders also distinguish between students who get admission through the government quota and through the management quota. For foreign courses, GRE/IELTS/GMAT scores is basic criteria on which a student gets the Institution.

5. The Process

Education loans are generally unsecured loan and are cheaper than personal loans but more expensive than home loans. Generally the education loan is to be applied jointly with the parents of the students wherein the parents act as a guarantor for the loan, they can also claim the tax benefits till the student starts repaying the same. Sometime the collateral is also required based on the credit score of the parents and amount required.

6. The Moratorium

Moratorium period is one of the unique feature of education loans. Here the borrower has the option not to pay the EMI for up to 12 months after course ends or six months after he starts working, whichever is earlier. However we should remember that this moratorium is not an interest-free period. The interest keeps accruing for the period we are not paying EMIs. Hence it is always better to start repaying EMIs as soon as possible to reduce the interest burden.

7. The Repayment

Generally the education loans are for up to 10 years which could be extended upto 15 years for big ticket loans—₹7.5 lakh or more. The EMI is less for long duration loans, but the total interest payout is much higher, So one should take the loan for the period based on the repayment capacity of self. Just because we can pay for longer term does not mean to stretch is at the maximum. The interest on education loan is tax deductible under Section 80E for up to eight years, so if possible it is better to pre-pay long duration loans within eight years. We should also pre-pay the education loan if there are better investment opportunities that offer better tax adjusted return than the cost of education loan.

Finally

The education loan is a good opportunity for those who have talent but are constrained by the economic reasons. However this is a loan and we need to asses our repaying capacity based on future income. Since this could be a first loan for a student and will have great impact on his credit score, we need to be extra careful in choosing the course and institute for the same.

Loans: Is it Good, Bad or Ugly ??

When I was very young my grandfather was planning to buy a house, as loans were not easy to get so the State Govt had come out with a scheme in which a person can buy the home and pay in instalments for next 15-20 years and the final ownership of the house is transferred after making full payment. However my grandfather decided to buy the house with full payment as taking a loan was something he call as “Shaan Ke Khilaf” i.e. bad for the Self Reputation.

Yes that was time when taking a loan by a middle class person was considered as “Daag” a blot in self-respect.

Time has changed a lot since then and now most of the people in 30s may have one or two loans. Yes we are in consumerism. We want to enjoy everything today whether we have money or not, does not matter as we can get loan for everything right from home to cars to electronic gadgets, for holiday’s and even weddings & other petty things also.

So few questions comes to our mind especially among young earners who find it tough to fit their expenses into their incomes:

1. Is it good to be debt free?

If we can control our expenses and don’t get carried away with other’s life style it is possible to live completely debt-free. However it is not necessarily a very smart way of living life. There are certain assets which requires a lot of money to buy like House, Car and college education, and very few people earn enough money to pay full cash for them on upfront basis. So in today’s world it may not be very smart decision to be totally debt free while denying ourselves some basics which can be paid back comfortably later on.

2. Should we borrow as we are getting it easily?

Now the next question comes should we borrow as someone is offering it. Now days most of use to get dozens of calls for personal loans, credit card etc. Does it mean that should we take it just because someone is offering it and use to buy the things which may not be otherwise bought? Nothings comes free and we should always remember it. If we have taken the loan we need to pay back along with the interest.

3. So what is Good Loan?

Good loan is something which is used to buy an asset that will grow in value or generate long-term income. Let’s understand it more.

A home loan to purchase a home for living is usually considered good loan. Home loans generally have lower interest rates than other loans, plus that interest is tax deductible.

Education loans to pay for a college education is another example of good loan. First of all, education loans typically have lower interest rate compared to other types of loans. Secondly the interest paid on education loan is fully deductible from the income and thirdly, a college education increases your value as an employee and raises your potential future income.

An auto loan is another example of good debt, particularly if the vehicle is essential to doing business. Unlike homes, cars and trucks lose value over time, so it's in the buyer's best interest to pay as much as possible up front so as not to spend too much on high-interest monthly payments.

4. What is Bad Loans?

Bad loan is a loan incurred to purchase things that quickly lose their value and do not generate long-term income. Bad loan carries a high interest rate, like credit card debt and there will be no tax benefits as such. The general rule to avoid bad debt is: If you can't afford it and you don't need it, don't buy it.

Loan for expense which can be avoided like wedding, electronic gadgets and fancy items whose value erodes quickly are considered as bad loans and should be avoided.

Taking Loan for a new start up can turn out to be a bad idea. Starting our own business can often be a life changing experience. However, we should avoid taking a personal loan for the investment. This is because there are plenty of better options such as roping in co-investors or angel investors, or choosing asset-based loans, small business loans, etc.

And the UGLY

Taking loan for Investing in stock market is risky, although there are people who may have made a fortune from their investments. However, if you want to invest in stock market by taking a personal loan be careful as it can easily end badly. Companies go bankrupt all the time, and if your money is on one then you could end up paying EMIs for a loan that dissolved completely. It can be further worse if you take a loan for derivative trading as then the liabiliites goes beyond the loan amount due to leverage trading.

Credit card is worse for undisciplined spenders. As we do not hesitate to swipe a card, since the brain is unable to process the pain of parting with money, while we focus on the joys of spending. Outstanding amounts are charged usurious interest rates since the unpaid balance is an unsecured loan to the cardholder. The minimum amount due seems small and convenient, but instantly converts the unpaid balance into a high cost loan.

5. So, why we should not overburden ourselves with loans?

Indebtedness is not just a financial burden but also emotional burden.  It can create resentment in our life and may affect our family and office work. People who carry huge debts face anxiety and depression. People start living in denial and lie through their debts, creating a façade of well-being while avoiding the calls from creditors, or stashing unopened mails about overdue debt away from sight. Indebtedness makes us less capable of being a better version of ourselves. It also affects our self-respect and we try to avoid people or places from where we have taken loans. It is always better to take loan which we can comfortably reply.

6. So, what is the thumb rule while taking Loan?

1. First thing we should know that will this loan have a direct and measurable positive impact on future income? If the answer is yes, we may go for it. Like Crop loan when sowing is good or an education loan for a course in a reputed institute could be a good idea.

2. Is the loan small enough for me to pay without impacting my other regular expenses? Rather than looking how much finance company give me we must look at our own cash flow position to ascertain that how much EMI I can afford to. There is an old saying “ Pair utne hi failana chahiye jitni lambi chadar ho” We should spread our legs only as much as the length of the sheet.

3. Is the loan creating an obligation whose value is too risky given the size of your assets? For example in derivative trades the obligation goes beyond the purchase amount and can put a huge obligation for the investor and hence doing derivative trading by taking loan can be a very dangerous idea.

Few Final Words

Loan is a commitment to pay from our future income for the things which we want to have right now. Yes we may take some of the things in advance by loan but we should be careful to manage them in case the future income does not comes as per our expectations. We should also remember that our loan EMI’s should not result into the curtailment of the current necessary expenses.

Warrant Buffet has once said: “If we buy the things we actually don’t need then in future we would be selling the things which we actually need.”