How to invest for your child?

Source: Courtesy: http://www.rediff.com/getahead/2005/sep/28baby.htm

I remember chatting with a father of two little girls. When he spoke of his daughters, his eyes lit up -- like most dads.

He had just one goal in mind. He wanted his daughters to get the best education possible.

So besides his retirement planning and repaying his home loan, he was also saving for their future education.

Six years ago, he began to invest every month in a diversified mutual fund for his daughters.

He began with an amount as low as Rs 500 a month and kept increasing it. Today, he invests Rs 7,500 in each of his daughters' names every month.

Though both are still in school, each girl already has Rs 7,00,000 to her name.

How did he do this? Through a Systematic Investment Plan in a mutual fund.

Mutual fund

An SIP allows you to deposit a fixed amount every month in a mutual fund. This money goes towards buying units of a fund.

If the Net Asset Value (price of a unit of a fund) is high, you get fewer units. If it is low, you get more units.

1. You can get great returns

Over time, the returns from SIPs are great.

Value Research, a mutual fund research organisation, did a study on 34 mutual funds in existence from July 1995 to June 2005.

The average point-to-point annual returns of these funds stood at 13.41%.

If you were a regular investor, investing the same amount every month in an SIP, the situation would be completely different.

Let's say you put in a fixed amount every month in a mutual fund. You would have made an average of 20.37% per annum (as against 13.41% in a one-time investment).

Here are the annual returns (given in percentage) over the various years from some consistent performers, had you invested in an SIP.

Fund	8 years	9 years	10 years
Franklin India Prima	23.83	30.38	35.78
HDFC Equity	25.17	29.09	33.22
Franklin India Bluechip	23.79	29.66	31.43
Franklin India Prima Plus	21.94	27.26	30.22
Birla Advantage	17.27	21.59	26.16
Prudential ICICI Power	13.14	18.86	23.86
Canexpo	10.17	16.28	21.90
Morgan Stanley Growth	10.41	15.21	20.35

8 year return as on June 30, 2003
9 year return as on June 30, 2004
10 year return as on June 30, 2005

• Mutual funds give great returns
• Returns delivered by funds via a one-time investment and SIP

2. Opt for a diversified equity fund

Since you are looking at the long-term and looking at your investment growing in value -- and not at a monthly income -- it would be wise to invest in a diversified equity fund.

Equity makes money over time. Moreoever, you have ample time to ride the ups and downs of the market.

If you are wary of investing solely in equity, try a balanced fund. These funds invest around 60% in equities (shares) and 40% in debt (fixed-return investments like bonds).

In such funds, the equity part of the portfolio is meant to generate superior returns while the debt component provides stability.

Though the returns tend to be lesser than a diversified equity fund, these funds are suitable for those who are not keen on taking risks or willing invest all their money in equities.

• Why you must invest in a balanced fund
• 5 great balanced funds

3. Opt for growth, not dividend

A mutual fund generally offers two schemes: dividend and growth.

The dividend option does not re-invest the profits made by the fund through its investments. Instead, it is given to the investor from time to time.

In the growth scheme, all profits made by the fund are ploughed back into the scheme. This causes the Net Asset Value to rise over time. The NAV is the price of a unit of a mutual fund. The NAV of the growth option will always be higher than that of the dividend option because money is being invested back in the scheme.

Since you are not looking at a regular income from this investment but are saving for a future date, opt for growth.

• Choosing between growth and dividend schemes

Public Providend Fund

You must open a PPF account in your child's name. You can do so even if you already have one in your name.

Investments in PPF get a tax break under Section 80C. The contributions made by a parent to the PPF in the name of the child are eligible for deduction u/s Section 80C.

The limit under Section 80C is Rs 1,00,000.

However, there is a limit on the PPF amount. You can only invest up to Rs 70,000 a year in PPF. This is irrespective in which account you invest in. The total contribution to the parents and child's accounts should be, at most, Rs 70,000.

The tax benefit does not get doubled just because you have two accounts.

Begin to regularly deposit small amounts into it. This investment avenue offers the benefit of tax exemption as well as consistent savings.

However, this money will have to be blocked for a long time. This account is for 15 years. When it comes to saving for your child, this limitation is beneficial.

Even if you put in Rs 10,000 per annum in your child's name for 15 years, at 9% per annum, you will end up with Rs 3,56,458 at the end of it.

• Make PPF work for you

Child plans

Child plans basically work like an endowment plan. Which means, on maturity of the policy, a fixed amount is returned to the parent.

This is how it works. The parents pay a premium for a policy. This policy is operational for a number of years. Should the parent die, the child gets the sum assured (amount the policy has been taken out for). Should the parent survive, the sum assured is handed over on maturity of the policy.

Say you want a huge lumpsum when your child turns 15 and is all set to go to college. So you should buy a 15-year policy when your child is born. You will have the option of paying the premium at one go or in phases. When your child turns 15, you get the money and can use it for whatever education expenses you saved it for.

Such polices cover the life risk for a specified period and at the end of this period, the sum assured is paid back to the policy holder.

You can check out the policies offered by Bajaj Allianz, Birla Sun Life, ICICI Prudential Life Insurance, Life Insurance Corporation of India, Max New York Life and SBI Life Insurance.

In addition, you also get child plans from mutual funds. Here, the fund manager invests the money just like a normal mutual fund but returns are not guaranteed. On the flip side, if he makes some smart investments, you could make a cool profit.

Child plans of mutual funds by design are similar to balanced funds. However, the fund manager will select companies that display long term potential as opposed to short-term returns, which any other balanced fund manager may look at.

The fund manager will look at companies that display superior opportunities for growth in the long term simply because most parents aspire to see a Net Asset Value that is slowly but steadily growing as opposed to a sharply volatile NAV.

• How to start saving for your child

Mix 'n' match

Don't just pick up one investment avenue. Each have their advantages and risk profiles.

An investment in a diversified equity fund will give you great growth but there is a risk it may not perform well too. The PPF and plans from insurance companies will give you the stability required. The child plans of mutual funds will give a lower risk than a diversified equity fund but a higher risk than PPF and insurance.

Alternatively, you could even buy some shares of companies. Over the years, their price is bound to rise. All the dividends that the company gives can be put into an account for your child. When you child comes of age, you can sell the shares and use the proceeds towards his end.

Financial institutions like IDBI and ICICI come out with long-tenure bonds. You could even look at those.

Ultimately, you will have to mix and match to ensure that you have comfortably invested for your child.