How to save for your child & retirement

Mutual funds are a great way to invest. We have heard sweeping statements like that many times in the past. What we haven't heard too often is how mutual funds can help you negotiate life's important milestones.

Personalfn evaluates how two of the more important life stages -- child's education and retirement planning -- can be best navigated with the help of mutual funds.

When we say its 'best negotiated' through mutual funds, we imply that there are other options at the individual's disposal to plan for his child's education and his own retirement.

Among the several investment avenues at his disposal, let us consider stocks and post-office savings schemes, as these are two investments that most households in the country have embraced at some point in time.

1. Stocks: Everyone loves them, but few can claim to have mastered the art of picking the right stocks. Most individual investors have a love-hate relationship with stock markets. The reason is simple -- lay, uninformed investors can muster the courage to enter equity markets only after they have appreciated considerably.

   By then, equity markets are all set to correct downwards. So individual investors invariably end up entering high and exiting low: the perfect recipe to lose money. Not something you can afford to do when you are saving for your child or your own retirement.

   Stocks can be a good means to achieve financial nirvana, but you need an expert (read fund manager) to help you get there.

2. Post Office schemes: Most tax-paying investors think about them only while planning for tax. However, the 'assured return' factor is a good draw for risk-averse, cautious parents to invest in National Savings Certificate (NSC) and PPF (Public Provident Fund).

   NSC and PPF do help individuals accumulate a corpus that can provide for milestones like retirement. The question is: will it be enough?

   There was a time not so long ago, when NSC/PPF gave investors a healthy 12 per cent compounded return. Those times are since long gone. Now we have NSC/PPF rates prevailing at 8 per cent, which just about takes care of inflation.

   Pick up any engineering/medical/management college prospectus, do the math and see if an investment that returns 8 per cent every year (compounded) can provide for the soaring college fees that are hiked more than 10 per cent every year.

   PPF/NSC do have a role to play in your scheme of investments, but if your investment corpus needs a big push, it can be provided by child-oriented mutual funds that invest a portion of assets in equities.

• Planning for your child's future
• Planning long-term? Get a pension!

Children plans/schemes launched by mutual funds have a clear mandate to invest with the objective of creating wealth over the long-term.

For instance, Principal Child Benefit Fund 'seeks to generate capital appreciation with the aim of giving lump sum capital growth to the beneficiary (child) at the end of the chosen period.'

HDFC Children's Gift Fund also seeks to provide capital appreciation to the investor (i.e. the parent). UTI Children Career Plan's aims at 'providing the child on maturity a means to meet the cost of higher education and/or to help them in setting up a profession, practice or business or enable them to set up a home or finance the cost of other social obligation.'

You can't get more explicit than that! From the parent's perspective having an investment option that works with the sole intent of creating wealth over the long-term for the child is a big plus.

Mutual funds show the way

Salient features of child plans:

a) Child plans have a lock-in; in most cases it's for three years. This enables the fund manager to select stocks that show long-term potential as he has time on his side to wait till his investments mature.

b) If the investor (parent) wishes to exit, he/she can do so by paying an exit load varying from 1-3 per cent depending on the mutual fund. In our view, the exit load is actually a good thing.

It encourages parents to leave the money untouched and show greater commitment in building a corpus for their children.

Planning for retirement

Likewise, mutual funds can also help individuals plan for retirement. As we have highlighted earlier in this article, stocks and post-office schemes in isolation may not be the ideal investment avenues for individuals to plan for retirement.

Stocks, because they are too complex and post-office schemes because they may not be able to give you an adequate return considering the high cost of living.

So where does that leave you? You got it -- mutual funds. A professional fund manager who understands the dynamics of the economy, equity markets, interest rates et cetera and how your investment interests can be best served under the circumstances.

While mutual funds are in an important cog in the wheel where planning for retirement is concerned, there are some issues you need to resolve. "How much do I save?" is the most important one. Individuals must endeavour to save enough to sustain their lifestyle.

One measure of this is try to accumulate a corpus that matches your salary at the time of retirement and gives you a healthy return on it. How do you calculate this figure 20 years before retirement?

That's quite a task, but if you do some basic math like assuming say a 10 per cent increment to your current salary, accounting for, say, 4 per cent inflation, you may arrive at a figure that will at least given you an idea. Of course, you will have to review your savings at regular intervals to ensure you don't stray from the course.

Another issue that needs to be addressed is: "Which asset is best suited for me?" This is a valid question given the number of asset classes at the investor's disposal. You have equities, bonds, gold, property, commodities, etc.

In our view, investors who have anything between 10-30 years left for retirement, must consciously make equity mutual funds a permanent feature in their retirement portfolio.

Younger investors must have a stronger bias towards equity funds; but they must reduce their equity fund allocation gradually as they near retirement.

Mutual funds boost retirement savings

Why are we so gung-ho on equity funds vis-à-vis relatively safer instruments like bonds, fixed deposits, property and gold? There are several reasons for that, but we list the three most important below.

1. Equities have a proven track record over the long term. Several studies have shown that over the long term (about 20 years) stocks have, in most instances, outperformed all other comparable asset classes viz. bonds, property, gold, fixed deposits.

   So if you do your homework well, there is a good chance that you will benefit from better than average long term returns.
   

2. Equities are your best bet to counter inflation. The abovementioned study also reveals that gains on equities have been highest after accounting for inflation. In other words, equities counter the inflationary impact better than other asset classes.

   Currently, given the concerns about inflation and interest rates, investors are better placed to appreciate this point.
   

3. Currently you may have read about international investment experts sounding gloomy about equities. Rest assured, they are referring to stock markets of developed nations like the United States and not about Indian equity markets.

   On the contrary, most international investment experts acknowledge that India is among the few destinations wherein equities are still attractive.

   India is among the few robust economies in the world that is clocking a GDP growth in excess of 7 per cent, which looks sustainable going forward. Evidently even international asset management companies and overseas employee pension funds have appreciated this fact that explains their presence in the country.

Now that you have settled 'How much do I save?' and 'Which asset is best suited for me?', let us understand: 'How I can go about saving for retirement'?

The answer to this question is a little complex as different individuals have varying needs and making generalisations is fraught with inaccuracies. Hence we lay down some broad guidelines that individuals can apply to build a retirement portfolio.

1. Give yourself at least 25 years for retirement planning (the more, the better). An early start is the secret to a financially secure retirement.
   

2. Mutual funds, particularly equity and balanced funds, must form a large part of your investment plan.
   

3. You need to commit money for retirement and this calls for discipline. Don't let the latest car model bought by your colleague or the latest mobile phone purchased by your neighbour, distract you.
   

4. Invest regularly. Investing a lump sum amount at one go, will not fetch the same kind of returns that you will get by investing the same amount in smaller portions over a period of time. This is referred to as systematic investment plan (SIP) by fund houses and allows investors to benefit from rupee-cost averaging.
   

5. Avoid drawing from your retirement savings as this defeats the very purpose of starting early.
   

6. Review your retirement portfolio from time to time (every 2 years or so). If there is an increase in expenses at present or if you anticipate higher expenses later, you may have to commit more resources to meet that shortfall.

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