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Child’s education goal: equity risk, debt stability or both?

Are equity investments too risky to cater to your child’s education goal? Should you then invest only in the stability of fixed income investments? The answers to these questions depend on your estimated expense amount for the goal and secondly, the time line for when you will need this money.

Are equity investments too risky to cater to your child’s education goal? Should you then invest only in the stability of fixed income investments? The answers to these questions depend on your estimated expense amount for the goal and secondly, the time line for when you will need this money.

A higher rate of inflation

All expenses you make in future will cost more to the tune of annual inflation or price rise in the economy. Various surveys and reports estimate that higher education costs tend to inflate or rise more than general inflation. If we assume this rate of inflation for education expenses to be a conservative 10% annually, it means Rs 5 lakh of expense today can cost up to Rs 13 lakhs 10 years hence, or close to Rs 10 lakh after 7 years.

To cater to this, you have to prepare investments that can potentially grow at a rate similar to this 10% education inflation. Anything less will leave you short of funds to pay for the potential cost.

Why equity helps?

Equity assets have the potential for above inflation returns over a period of 5-10 years. This happens due to the compounding earnings growth and therefore, compounding stock price of the underlying company. Thus, a good quality equity portfolio invested in for 5-10 years can help you beat inflation and achieve the corpus you require. Historically, the expectation of long-term return from equity is an annualised 12% or thereabouts. The key is to remain invested.

Equity investments can help you achieve your child’s education goal more effectively if you start early. The longer you remain invested the higher the chances of achieving the required rate of return on your investment. So, if you have only 3 years to the goal, equity is not the right choice, but if you have 10 years then you must include equity investments to achieve this goal.

Do you need fixed income?

Fixed income or debt investments give you steady returns; however, post tax returns can be below inflation. While you get steady income, you don’t really grow your money. Education costs, in the meanwhile, can increase at a much sharper pace.

Today you can expect a post-tax return of around 4.5%-6% per annum (depending on your tax bracket) from a fixed deposit. But this will hardly suffice in planning for education costs which can increase 10%-12% annually. Hence, debt investments by themselves will not help. However, consider apportioning some amount to act as a cushion against the volatility in equity. How much you apportion will depend on how many years you have for this goal. The longer you have the lesser you need to apportion in debt investments.

Equity investments can help you achieve your child’s education goal more effectively if you start early. The longer you remain invested the higher the chances of achieving the required rate of return on your investment. So, if you have only 3 years to the goal, equity is not the right choice, but if you have 10 years then you must include equity investments to achieve this goal.

Caveat

Ideally, your child’s higher education corpus requires both equity and debt investments. Equity provides the growth in your funds and debt investments give you the stability when you need it. In both investments, you must be careful about the quality of the securities you choose. Also, rationalise your required investment amount, if time is short.

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