Child Education Planning: The Nuts and Bolts of it

Off late, there’s been a lot of buzz regarding ‘Child Education Planning’ – and the folks who are making the most noise about it are the life insurance companies! So should you blindly take up a ‘child plan’ and leave it at that? In this brief article, we’ll try to bring you up to speed about the various angles you need to consider while planning for this important financial goal.

A hard look at the facts

It’s a painful truth that in India, education expenses have been inflating at a much higher rate than regular inflation. In fact, a recent article Economic Times article^ suggests that MBA costs are expected to rise at 15.26% per annum and other undergraduate expenses 12.59% in next five years. Assuming that inflation will moderate somewhat over the long term, we can still rationally expect education expenses to inflate at 9% to 12% per annum for the next decade or so. And what’s more, the tuition fees are not the only expenses one needs to save for – there’s also rent for hostel or PG accommodation, books or study materials and what not! So all in all, (assuming the higher probability outcome that your child will pursue a non-government college education) the cold hard fact is that ten years hence, higher education is indeed going to be frightfully expensive.

Student loans are expensive…

Interest rates for student loans are typically 1.75% to 3.75% above the base rate. Though it’s extremely difficult to predict interest rates 10 years hence, it’s a safe assumption that interest rates on student loans will not fall below 10%. At that kind of rate, your child (or you!) will be saddled with an EMI of approximately Rs. 21,000 per month per 10 Lac of loan taken for the first five years of your child’s career!

What this essentially implies is that either your child’s working life will be off to a debt-ridden start (that may lead him or her to make wrong career choices), or you’ll land up paying EMI’s in your near-retirement phase (when you should be focusing on accumulating a corpus for your non-earning years instead). Either way, a post- MBA EMI of Rs. 40,000 to Rs. 50,000 is bound to hurt… bad. Even worse, you could end up liquidating your nest egg to fund your child’s education – an all too common scenario in our country!

And to make matters more complicated, there’s no saying how the job market or economy will be ten years down the line when your child graduates with a professional degree. Clearly, the need of the hour is advance planning and preparedness.

When it comes to higher studies, quality counts…

A report published by the Georgetown University Center for Education and the Workforce suggests that the quality (A, B or C Grade), extent (Bachelors, Masters or Doctoral) and field of education (Management, Science or Technology) impacts lifetime earnings of an individual by 20-50%. Over the course of one’s career, that’s several Lacs of Rupees! Clearly, this is one goal that you wouldn’t want to make any kind of compromises with.

Have time on your side? Let compounding work its magic!

When you’re planning for your Child’s education, time really IS money! Start early and save the majority of your funds into high return savings instruments that have the potential to deliver a CAGR of over 12% in the long run. Restricting your savings purely to low risk, low return instruments (such as recurring deposits and traditional ‘child plans’) might lead to you falling well short of your savings target. Even ULIP’s tend to fare worse than top quality mutual funds and have higher inbuilt costs too. Check out how much you can accumulate over various time frames and return scenarios by saving just Rs. 15,000 per month over the long term. Note how the effect of compounding kicks in with increasing timeframes.

As you can see from the above table, a balanced savings mix yielding 10% per annum can help you accumulate enough to fund your child’s undergraduate and postgraduate studies by saving just Rs. 15,000 per month over a 10 year period. This is no doubt a gross oversimplification and your own scenario will vary depending on your existing provisioning, aspirations, income and several other factors. This is just an illustrative example.

Should you “protect” this goal?

Unfortunately, life has its own set of uncertainties and we need to account for them by managing risks appropriately. So yes, it is recommended to “protect” this goal by taking out an adequate life cover specifically for this goal so that in case of any unfortunate eventuality, your aspirations for your child’s higher studies are still fulfilled. Your own “goal protection” strategy warrants a discussion with your Financial Planner, who can help you work out an appropriate plan after taking all factors into account.

We recommend…

First and foremost…start early – the earlier the better! We have clients who start planning for the higher studies of their new born kids, and that’s the best possible thing to do as they’ll have a full 18 years to save up. If, however, you have only a few years to go, you’ll need to restrict yourself to less aggressive instruments and take out an education loan for the deficit amount.

If your time horizon is fairly large, you should choose a mix of aggressive equity SIP’s and traditional endowment life insurances to create a balanced savings portfolio with an inbuilt goal protection component.

Mutual funds are inexpensive, transparent and easy to understand. Unfortunately, they are also far too lenient on the erratic investor! You may be tempted to invest when the market is on a roll, and sell when the markets are down, but this is the wrong approach that will definitely not help you achieve your goal! Also, since mutual funds are highly liquid, there’s always the temptation to redeem them to serve our more immediate pressing needs – like buying a 100 inch flat screen TV to watch the World Cup, for instance! Endowment insurances on the other hand have inbuilt penalties that enforce savings discipline - so although they are lower return instruments; they end up delivering the goods by inculcating your savings habit more effectively than SIP’s. A well planned mix of both should do the trick.