Funding The College Dream
A major aspiration for most individuals who have minor children would be to fund their children's higher education. In fact, it is the most common financial goal among individuals around the world, after retirement planning. And much like planning for retirement, planning for our children’s education is a goal that needs to be planned for and achieved over a number of years. Therefore we need to give ourselves enough time to create an adequate corpus for our children’s education and plan accordingly along the way. And therefore, today's post is going to be dedicated to talking about how we can go about planning for our children’s education. Rather than talking about the best investment products to pick when planning for our children’s education, this post is going to focus more on laying a process in place to plan for this goal.
The starting point of our efforts to plan for our children’s education should be to have a reasonable estimate as to how much money we would require to adequately fund our children’s education. The essential challenge in getting this done is the fact that we may not have a clear idea of which undergraduate and/or postgraduate courses to plan for right from the beginning. A smart thing to do would be to look up the current average cost of undergraduate and postgraduate courses in India. If we wish to send our children abroad for their education, we would need to look up current education costs in the foreign countries of our choice as well. Next, we must understand the rates of inflation applicable to education costs in the country of our choice. A good thumb rule is to assume an education inflation rate that is twice the headline inflation rate in a particular country. In the case of India, given that headline inflation rates average around 6%, a realistic estimate for education inflation would be 10-12%.
The above graphic shows how costs of various courses will rise owing to inflation over the next decade. This clearly means that planning for our children’s education would involve significant costs, regardless of the courses we choose to plan for.
Once we have a reasonable estimate of the amount we require, the next step would be to judge when to begin planning for the goal. Most parents usually wish to plan for their children's graduation and post graduation. Students would typically begin their graduation when they turn 18-19 years of age. This clearly means that planning our children’s education is an essential long term goal, and we need to give ourselves as much time as possible to plan for our children’s education. Therefore, the ideal time to begin planning would be shortly after the child is conceived and we know that we would be becoming parents in the near future. Having a plan in place and putting it into action 6-8 months before the child is born would be a great start. But that may not be possible for some of us. Even so, we would need a minimum of 12-15 years to effectively plan for our children’s education. Therefore, we must put our plans into action by the time our children are 3-5 years of age. Starting any later may mean that we would need to make significant investments to make up for lost time. And this may put our finances under severe stress.
Once we have the foundation of our plan in place, it would be time to conceptualise our investment operations, asset allocation strategies and return expectations. As we have seen by now, planning for our children’s education is a goal that falls due several years into the future and involves significant cost outlays. Therefore the best way to invest for such goals is to make our investments in the form of monthly instalments with an annual increase of at least 20% in our monthly investments. For instance, if we invest Rs 1,000 per month in the first year we must look to invest at least Rs 1,200 (1,000 + 20%) per month in second year, Rs 1,440 (1,200 + 20%) per month in the third year and so on. As far as asset allocation is concerned, we must have a significant allocation to equity equity (stocks and mutual funds) in the initial years and look to move more and more money into debt (fixed deposits, recurring deposits and cash) as the goal comes closer to falling due. A sample asset allocation plan in accordance with the child's age is displayed in the graphic below.
Because we would be reducing our exposure to equity in a progressive manner over time, it would be unrealistic to expect handsome returns in the region of 15-20% on a consistent basis from our portfolios. If we choose to have 100% allocation to equity in the initial years, a realistic expectation for portfolio return would be somewhere around 10%. (A realistic return expectation from equity as an asset class would be inflation + 4% to 5%. And given that inflation in India averages around 6%, it would bring the return expectation to anywhere between 10 and 11%). As we reduce our equity allocation, our return expectations must also drop. Towards the later years when we would only have a 10% allocation to equity, we can safely expect a return of 7% to 7.5% on our portfolios.
If we are planning the education of two or more children, we would also need to decide how we would bifurcate our monthly investment amounts among each of our children’s portfolios. Also, we need to prioritise the goal of planning our children’s education within the list of our other financial goals. In other words, we must decide whether or not we would be willing to lay lesser emphasis on our other financial goals in favour of our children’s education if the situation demands it. There is no thumb rule or guideline with regard to bifurcating our investments between our children or the way we prioritise our financial goals. It is completely a matter of personal preference and judgement. The key here is for there to be clear communication and clarity among all members in our family with regard to the way we have chosen to prioritise our goals and what that means for our plans to provide for our children’s education.
So as is clear by now, the work towards planning our children’s education should begin well before our children are born. The costs involved in accessing a good education are already significant today, and will only increase in the future. It would be unrealistic to expect exorbitant returns on the portfolios we create to provide for our children’s education. Therefore our best chance of success would lie in staying disciplined with our investments and increasing our investment amounts at regular intervals, while keeping our return expectations realistic at all times. Having a clear plan on how to split our monthly savings becomes crucial when we are running a plan for multiple children. Whether or not we give our children’s education precedence over our other financial goals is something that is entirely up to us to decide. What is important is that we plan well in advance, make the right decisions and follow through on them with discipline and precision in order to allow our children to live the college dream we had envisioned for them.