BT Insight: Are children MFs good to fund your child's future?

One of the most important financial goals which most of the parents have is collecting adequate funds for their children's future whether it is for higher education, profession or marriage. Although there are many long-term investment options, mutual funds also offer a specific product targeted for this need -- children funds. We tell you how these funds work and whether you should go for it to meet your children-linked life goals.

Why inflation beating return is a must?

The elevated level of inflation makes it daunting as future prices are expected to be much higher than the current prices. The education cost has been of a particular concern due to its exponential rise in the past and most likely its unabated continuation in future.

"As per rough estimates, education inflation is around 10-12 per cent. Even if we take half of the estimated rate (around six per cent), a graduate course that costs around 5-6 lakhs today, will cost around Rs 15 lakh in around 15 years. Hence, parents of new-born babies need to start planning soon to ensure that by the time the child enters college, they have the required funds to manage the education costs," says Harsh Jain, Co-founder and COO, Groww.

If you depend only on safe deposit options like fixed and recurring deposits, there are chances that your post-tax return will slip below 6 per cent in the long-term which may not be enough to match with the higher inflation of education cost.

This is where equities come handy as a tool to generate inflation beating higher return in the long run. Not every investor is savvy enough to manage equity investment on their own, so a mutual fund helps you get the benefit of equity investment as equity experts of MFs manage your investment. Should you go for general equity mutual fund or children-focussed funds:

How child funds differ from general funds

Under new Sebi categorisation, the solution-oriented funds are known to cover goals like child's education and retirement. The basic purpose of these funds is to help investors save money and make it grow to meet specific future expenses.

"Children funds are meant for meeting a specific goal of investing for your child's future, be it education or marriage. The investments are made in the name of a minor investor by their parents/guardians. These funds have lock-in period of a few years or until when the child gains major status which ensures investment discipline is maintained," says Kaustubh Belapurkar, Director - Fund Research, Morningstar India.

It means unlike other open-ended equity mutual funds these funds have a lock-in period to discourage the exit in the short-term. On one hand it looks like a restriction, on the other, it prevents compulsive exit by investors facing even a minor financial stress.

"The emotional quotient encourages investors to look at these funds as long-term investments and dissuades them from redemptions due to short-term market fluctuations. Both these factors combined help investors reap long-term benefits. Even when seen from the perspective of the fund managers, they treat such funds as long-term investments and can thus take long-term calls, bereft of the fear of sudden large redemptions," says Col Sanjeev Govila (Retd), a SEBI Registered Investment Advisor.

Deciding the right strategy

When you are saving for the long-term you are bound to face a lot of uncertainty be it the growth of your income or interest rate or return on equity investment. You need to have a long-term strategy for your investment for not only meeting the desired saving rate but also the desired return.

"One should have a clear idea about the investment's asset allocation and judiciously find the balance between equity and debt mutual funds schemes," says Rishad Manekia, Founder and MD, Kairos Capital Private Limited, a Mumbai-based financial planning firm.

Equities are known to deliver higher and stable return over a long-term of 10 years or more. "Typically most child plans offer multiple plans for varying investment horizons and risk exposure. The more aggressive plans will invest a large part of the portfolio in equities; this is useful when the investment time horizon is long," says Kaustubh Belapurkar of Morningstar India. It means you should keep highest exposure in equities initially as you have time by your side.

However, if your child's education or marriage goal is near, you may go for conservative plans that offer higher capital protection. "Conservative plans typically invest a bulk of their portfolio into fixed income products. These plans are suited for the ones whose goal is in the near future," says Belapurkar.

Selecting a right fund

Besides the right strategy the most critical part is selecting a right fund that meets your requirement and risk-return matrix in the given investment period. All children funds are not similar as they may adopt quite different investment strategy with varying degree of risk. A simple thumb rule is to identify suited MF schemes as per time horizon of your investment.

"In such funds too, like conventional wisdom, foremost remains the purpose of investments, next could be duration of investment and then the risk appetite. Pure equity funds for investment periods of more than seven years, hybrid (equity oriented or debt oriented, as per risk assessment) could be looked at for periods of four-seven years and debt heavy funds for lesser periods. Dynamic Asset Allocation Funds could be an all-season recipe for more than four years if equity exposure is acceptable," says Col Sanjeev Govila (Retd), a SEBI Registered Investment Advisor.

Once you have decided the kind of scheme and asset allocation you would want you need to compare the funds and check the previous track record.

"Investors can check mutual funds rankings provided by various research firms such as CRISIL, Morningstar and Value Research. From the list, an investor can filter out mutual funds which are consistently ranked 4-star or 5-star over long periods of time and check that the objective of the fund matches the risk-return profile that the investor is looking for," says Manekia of Kairos Capital.

Gradually increase SIP contribution

Many times, your current income may not be sufficient to allow you to do the desired level of saving however with time as your income increase you should make it a point to cover the lost ground by increasing your investment.

"Investing for children's education is a long-term process. Hence, over time, parents can experience an increase in income. While this usually translates into a better quality of life, it is important to dedicate a small portion of the increased income towards the investment that will fund their child's education" says Jain of Groww.

One of the best strategies to make sure an income rise does not get wasted for consumption and is rather utilised towards long-term goals is to have a clear demarcated goal for saving. "When you see an increase in income it is always good to try and save at least 50 per cent of that increase. This helps to keep lifestyle inflation in check and maintains a good habit of saving and investing" says Manekia of Kairos Capital.

Regular saving through SIP is the best way to channelise your saving for long-term goals and it is also the most convenient product to enhance your regular saving even with lower amount. "When they get a salary raise or have an increase in income via other means, it is important to increase the SIP amount too. This can help them reach their financial goal faster," says Jain of Groww.

Should you depend only on Children MFs?

As far as returns are concerned, children's fund as a category has performed like many other diversified funds. While the top fund in the category HDFC Children's Gift Fund has delivered an annual return of 11.77 per cent over a 10-year period, the number goes down to less than 3 per cent for the bottom performer. Therefore, all children's funds are not performing as expected and you need to be selective in picking the right fund.

However, depending only upon the children's funds may not be the right investment strategy. "Diversifying investments is always a good idea. While most solution-oriented plans make people believe that investing in any one of them is enough, but mutual fund investments are exposed to market risks. Whether the investor opts for equity, debt, or hybrid scheme, there is always a possibility of the scheme not performing as per expectations due to external market factors. A child's education cannot be exposed to risks. Hence, it is prudent to use a basket of investments to work towards the desired corpus within the desired time," says Jain of Groww.

You can also follow an investment strategy of these top-performing funds without related restriction by using open-ended mutual funds. "It is better for an investor to replicate the strategy with a mix of lower cost open-ended equity and debt mutual funds. Such a strategy would give flexibility, better liquidity and returns as per investor risk appetite without compromising on the same financial goal," says Manekia of Kairos Capital.

Should you only depend upon equity mutual funds or use other products as well? "Mutual funds not only invest in equity, but also in other asset classes such as debt, gold and so on. Therefore, depending on the investor's need and profile, a large portion of the portfolio can go into different types of mutual funds schemes," says Col Govila. So, you have the option to achieve the desired diversification within mutual fund space.

However, there are some excellent fixed income products which may appeal to large section of investors. "If the investor is totally averse to the idea of variable returns and no visibility of the exact amount (even if low after taxation) at the end of the investment tenure, then mutual funds may not be for such an investor. They should resort to other fixed income products like Public Provident Fund and Sukanya Samriddhi Account." says Col Govila.

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