Children’s fund is an open-ended mutual fund available for investment for children. This fund has a mandatory lock-in period of 5 years or until the child becomes a major, whichever is earlier. It is a mutual fund for child-specific goals like meeting their educational expenses, relocation, or other essential expenses. Children’s funds invest in both equity and debt securities. Investors can choose for a higher equity or higher debt based on their investment horizon and understanding of risk. The tenure of the mutual fund is a minimum of 5 years and can be extended up to the time the child has attained majority.
Investors cannot withdraw the money invested in this fund prematurely, hence making it an idle long-term investment. This will also give time for the portfolio to ride market ups and downs and stabilise the returns. Also, suppose the investment is withdrawn prematurely before the minimum lock-in period. In that case, the fund houses charge up to a 4% penalty as exit load.
Also, parents investing in children’s mutual fund plans can avail an exemption up to INR 1.5 lakhs under Section 80C of the Income Tax Act, 1961. Moreover, the interest earned from these funds is exempt from tax. However, upon maturity, the returns are taxable.
Once the child becomes an adult, they can complete their KYC and gain access to the funds. Also, they will have the flexibility and authorization to use the money for building their careers.
Following are the advantages of investing in Children Funds:
Small Savings: Child plans are good investment schemes that help parents to start saving for their child’s future. Doing small regular investments help in meeting long term expenses of a child easily. For example, higher education, marriage, etc. Also, having such a fund will encourage children to pursue their aspirations without having to compromise due to financial limitations.
Asset Allocation: Children funds are a type of hybrid funds or balanced funds. Therefore, parents or guardians can opt for either an equity-oriented fund or a debt-oriented fund. On the basis of the willingness to undertake the risk, one can choose a suitable asset allocation.
Multiple Goals: Children’s plans allow parents or guardians to allot different funds for appropriate goals. As a result, the investment portfolio will have well-segregated investments—for example, child’s schooling, higher education, marriage, healthcare needs, etc. Different goals for different phases of life can be attained through children’s mutual funds.
Tax Benefit: Debt-based child plans are tax efficient. Investments up to INR 1,50,000 per annum in children plans qualify for tax exemption under Section 80C of the Income Tax Act, 1961. Also, the annual exemption of INR 1,500 per child as per Section 10 (32) of the Income Tax Act, 1961 is allowed if the interest income exceeds INR 6,500 annually. Furthermore, parents of children suffering from any disability qualify for additional tax benefits if they apply for children’s funds. Also, taxes payable during redemption will be less due to the indexation benefit.
Lock-in Period: Most children’s funds have a lock-in period of five years. However, parents or guardians can voluntarily increase the lock-in period until the child attains maturity, i.e., 18 years. The Lock-in period ensures the investors don’t withdraw their investments. Also, for child plans, long durations help in meeting the child expenses.
High Returns: Child funds can be either equity-oriented or debt-oriented. Long term investments in equity-oriented schemes have the capacity to generate significant returns. Therefore, investors who are willing to take the volatility associated with equity investments can opt for the equity-oriented fund. In contrast, debt-oriented funds offer more or less stable returns in comparison to equity funds.
Children’s mutual funds are managed by professional fund managers. As a result, even if an investor has little or no market understanding, they can invest in the best children’s mutual funds. Such professional management helps in maximising returns.
Limitations of Investing in Children Funds
Exit Load: Children’s mutual funds have a minimum lock-in period of five years. Premature withdrawals come with a high penalty in terms of exit load. The exit load for children’s funds can go up to 4%. Therefore, one should be cautious while choosing a fund and also in case they are opting for premature withdrawals.
High volatility: Mutual funds are highly volatile investment options. Children’s mutual funds can also be highly volatile based on the asset allocation. Equity oriented funds are more volatile in comparison to debt-oriented child funds. Therefore, one should be considerate about the volatility factor while choosing a fund for their child.
Who should Invest in Children’s Funds?
Children’s mutual funds best suit investors who want to secure their child’s financial future. These tailor-made investment plans help investors to save up for their child’s education and other essential expenses. Since these funds fall under the tax exemption category, parents looking for tax saving as one of the goals can invest in these funds.
These funds come with a minimum lock-in of 5 years and a heavy penalty for premature withdrawals. Hence investors who are willing to stay invested for a long tenure can invest in them. Since Children’s funds are tailor-made and customisable, investors who are looking for the flexibility to choose lock-in period and portfolio (between debt-oriented and equity-oriented) can consider investing in them.
Things To Consider Before Investing in Children Funds
Investment Goals: Mutual funds offer multiple schemes for different goals. Similarly, saving for a child’s future can be done by investing in Children Funds. Children Funds are suitable investment options for parents who are willing to invest for a long-term duration in the equity and debt instruments. One can have an investment portfolio with well-segregated investments. In other words, different goals for different phases of life can be attained through children’s funds.
Investment Duration: Children’s funds come with a lock-in period of five years. Furthermore, parents or guardians can extend their investments until they reach maturity, i.e., 18 years. Therefore, one should consider the mandatory lock-in period and penalty before choosing a fund.
Returns and performance of the fund: Historical performance may not guarantee future returns. However, one should thoroughly analyse the historical performance of a fund. The consistency in generating significant returns and outperforming the benchmark are important factors to consider before investing in a mutual fund. Therefore, always look for funds that have performed well across different market cycles.
Exit Load: These mutual funds often have a high exit load. If an investor prematurely withdrawals, the exit load can go up to as high as 4%. Therefore, while investing in a mutual fund, considering the exit load of the fund is important.
Documentation: There is quite a bit of documentation for investing in children’s funds. Parents or guardians have to provide official documents to prove their relationship with the child. Also, during redemption, additional documents pertaining to the child will have to be submitted.
Lock-in Period: There is a mandatory lock-in period of 5 years for children’s funds. Also, the penalty for withdrawing prematurely is quite high. The lock-in period ensures the effects of market volatility on the portfolio are reduced. Hence investors have to consider this before investing in these funds.
Cost of Children’s Funds: Children’s fund comes with a cost, and it is called the expense ratio and exit load. The expense ratio covers all transaction costs, fund management fees, market and distribution costs. In contrast, the exit load discourages all premature withdrawals. The expense ratio is a mandatory expense, while the exit load can be avoided by staying invested until the lock-in period ends. Hence investors have to consider these expenses before investing in children’s funds.
Taxation of Children’s Funds: Children’s plans come with a tax benefit. Investment in these funds qualifies for tax deduction up to INR 1.5 lakhs under Section 80C of the Income Tax Act, 1961. However, the maturity proceeds are taxable as per the regular tax rules. For equity funds, capital gains above INR 1 lakh are taxable at 10%. Whereas, for debt funds, the capital gains are taxable at 20% with indexation benefit. Hence investors have to consider the taxation of the returns from these funds before investing in them. However, from April 1st 2023, capital gains from debt mutual funds will be taxable as per the investor’s IT slab rate. Thus, debt funds will no longer have the LTCG benefit.
Alpha and Beta: It is a measure of a mutual fund’s performance against its benchmark. In other words, it shows how well the fund has performed against its benchmark. A positive number shows that the fund has outperformed the benchmark. Beta measures the sensitivity of the children’s fund to stock market movements. A beta that is more than one shows the fund is very sensitive to market movements. A beta that is less than one shows lower sensitivity to market movements. However, if the beta is one, then the fund’s portfolio moves in tandem with the market.
Standard Deviation: Standard deviation measures risk in the portfolio by measuring the volatility of returns from its average return. A high standard deviation shows that the fund is highly volatile.
Portfolio Turnover Ratio: The portfolio turnover ratio shows how many times the fund’s portfolio has changed in a year. A lower portfolio turnover ratio is better as the transaction costs and sometimes capital gains tax will be lower, hence reducing the fund’s overall expenses.
Sharpe Ratio: Sharpe ratio measures the fund returns considering the systematic risk or standard deviation of the fund into account. It is the risk-adjusted return of the fund. Hence, a higher Sharpe ratio is better.
R-squared: R-squared is a statistical tool that shows how much of the fund’s movements can be due to the market or benchmark’s movements. It ranges from zero to 100, showing no correlation to a high correlation to the market.
Frequently Asked Questions
How do I open a mutual fund for my child?
Many financial firms offer children mutual funds that parents can open for their children. The process of opening the fund requires the parents to present to the fund house the necessary documentation. To open a minor’s mutual fund folio, the parent must provide 2 key documents. Firstly, the proof of age and date of birth of the minor must be provided. The documents such as passport, aadhaar, birth certificate can be presented as a proof of age and date of birth. Secondly, the proof of their relationship with the child must be submitted. For such purpose the birth certificate or the passport mentioning the name of the parent must be submitted. Also, during redemption, additional documents pertaining to the child will have to be submitted.
Can I gift a mutual fund to my child?
You can gift a mutual fund to your child, financial firms offer dedicated children mutual funds that parents or guardians can invest in for their children. The fund comes with a mandatory lock-in period of 5 years or until the child becomes a major. It also can be tailored to serve different purposes such as child’s schooling, higher education, marriage, and healthcare needs. The investor investing on the behalf of the minor or gifting the mutual funds to a minor must provide a proof of relationship of either a parent or a legal guardian.
How do I invest on behalf of my child?
Parents can invest on behalf of their children, there are several schemes dedicated for children. Also, parents can invest on behalf of their children through a custodial account which they can use to invest in many types of securities like stocks or mutual funds.
How do kids buy mutual funds?
Kids cannot buy mutual funds on their own since they are minors. However, parents or guardians can buy on behalf of the kids. This requires the parents to submit proof of the relationship with the kid. Although the account is opened by the parents, the account is owned by the kid.
Can I start an investment fund for my child?
You can start an investment fund for your child. If you are planning to hold the investment for the long term to cover the child’s future needs, you can invest in a children fund. This fund comes with a mandatory lock-in period of 5 years or until the child becomes an adult. Also it can be designed to cover different future needs such as marriage and education.