Attending a mundan ceremony in the family, I was fascinated by the earnestness with which young parents were providing for their children. After a few years of enjoying their new income and the bursts of spending associated with getting married, most young couples begin to save in earnest when a child is born. What are the choices they make? How can they do better? Opening a recurring deposit account, a PPF account, or buying gold each year are traditional saving routes. Buying insurance policies and beginning SIPs in mutual funds are the relatively modern options. My conversations with young parents brought home a common misgiving. They invariably think that saving and investing are not too different. They think they need to save as much as they will need in the future. They measure themselves on the basis of how much they save, not how well they invest. Not enough thought goes into how the saving will be invested and whether those choices make sense over the long term. Good investment habits begin with asset allocation. It is the single most important strategic decision in investing.There are five types of assets that are chosen by most investors: equity, debt, cash, gold and property. Every investment decision is a choice among these products. The way in which the savings will grow over time depends on how much is invested where and for how long. Equity (shares, equity funds) is a growth asset. It provides little by way of income (dividends), but holds the potential for long term capital appreciation. Debt (deposits, debt funds, bonds, PPF, saving schemes) is an income asset. It provides interest income or grows at a rate close to the rate of inflation. Cash is purely for liquidity. Savings are parked in cash before they are put to other uses. Cash is not expected to earn anything. When parents choose debt instruments for their children, they are simply ensuring that their savings earn enough to cover inflation. The safety of such instruments leads them to believe that they have taken the right decision. However, given the long-term nature of their needs, they should choose growth assets like equity. I would say that the parents who are not investing in equity for their children are needlessly short changing themselves. They are simply not doing enough. If savings merely cover inflation, each rupee required in the future will have to be built by savings alone, and it might fall short. For instance, to provide for the higher education of a child, assume Rs 100 is set aside at, say, 8.5% per annum over a 15-year period. It would grow to about Rs 317 over this time. There are two aspects to consider here: First, Rs 317 might not be enough to cover the desired need, if cost of education appreciated at a rate higher than 8.5% per annum. This is the risk of inadequacy of corpus. Second, of the Rs 317 being allocated to education, Rs 100, or over 30%, comes from parents' savings—the proportional contribution. If a large lump sum is needed in the distant future, the ideal asset allocation is a growth asset. This could be investment in an equity mutual fund that provides the scope for capital appreciation. The same Rs 100 growing at 17% per annum (look up long term return of equity mutual funds that have a history of 15 years or more and you will find that this number is not unrealistic) would result in a corpus of Rs 927, or three times the conservative investment at 8.5% per annum. Capital appreciation or growth in the value of investments addresses both the problems we discussed earlier. By allowing it to grow at a rate higher than inflation associated with most needs, the parent ensures that the corpus is adequate to meet the future need. Second, only 11% (100/927) of the final corpus comes from the savings of the parent, while 89% of the final sum has come from appreciation in investment value. It is important to evaluate investment options from these points of view. It might feel nice to pay insurance premium on a product that is advertised as providing for the child's education. The real test of the product is whether the corpus would turn out to be large enough, and whether it would demand a proportionately lower contribution of savings. In other words, the investment has to do more. It needs to power up the savings to make it bigger and better. Parents feel duty-bound to provide for their children. It is tough to point out that they should not patronise their wards so much. Many would not only want to fund their children's higher education and marriage, but also leave behind assets for them. This is where investment in gold and property come in. Both are highly favoured and parents view the allocation to these two assets as 'investments'. The problem with both these assets is not just about them being physical assets, subject to cycles, or being swayed by the black market. The real problem is the cost, paperwork and hassle in dealing with them. It is tough to sell property. There is a stiff stamp duty to pay. The costs of buying and selling gold can be 15% or more. Then there is the social stigma that is attached to the sale of these assets. Selling gold or property to fund higher education or marriage of a child is still looked down upon as an act of desperation. Even if the parent leaves behind property for the child, the persistent maintenance costs, the high obsolescence value, and the hassle of paperwork makes it a cumbersome asset to manage. Financial investments are relatively easy to hold, manage, transfer and liquidate. Before mindlessly buying assets, or being content with RD and PPF, parents should take a few minutes to ask whether their investment plan passes the test of being smart and suitable. Otherwise, they may be diligent and duty-bound, but may not be doing enough for the child.   Top | Back     Please do not reply back to this mail. This is sent from an unattended mail box. Please mark all your queries / responses to webmaster@dreamzunlimited.org Information provided on this newsletter has been independently obtained from sources believed to be reliable. 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