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How to invest for college education goals for teenaged children?

Posted on 06 Nov 2022
Author: Sayan Sircar

Tags: Children

6 mins read
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This article discusses where to invest for college education goals based on when college starts and your retirement date with a focus on lowering taxes.

How to invest for college education goals for teenaged children?

📚 Topics covered:

Introduction
Using the Have-vs-Need framework
Applying the HvN framework to the college goal
What are the benefits of the HvN framework for this use case?
What should you keep in mind before applying the HvN framework?
How to apply the HvN framework for college goals?
What if the goal is due too soon?

Introduction

Investing for teenagers for college education has its unique set of challenges.

On one side, you have a good idea of your income over the next 5-10 years. Knowing your income allows you to pinpoint a ballpark figure you can pay as college fees.

On the other hand, you will face uncertainty regarding where the child will finally study since factors like choice of subject, college, location, and entrance examination results are unknown.

Nevertheless, the income and investments factor places an upper cap on the amount you can reasonably spend. Since financial planning does not happen in isolation, you have to balance the amount you wish to pay for the college goal vs other goals like retirement.

If you already have some amount invested for a college goal in equity, you need to have a rebalancing plan to derisk the corpus from an equity market fall. This post shows a way to do that in a way to minimise portfolio risk while also reducing the taxes you need to pay.

Using the Have-vs-Need framework

Have vs Needs Framework

The Have-vs-Need (HvN) framework needs you to make a 4x4 simple table with three asset class buckets. For each bucket, you need to calculate three numbers: the amount you already have (the HAVE column), the amount you need to reach your goals (the NEED column) and the difference between the two (the GAP column).

The three buckets are:

equity bucket for long-term goals while beating inflation
debt bucket to either generate income or provide stability vs the equity bucket
cash bucket for spending for short-term goals

The columns are:

HAVE is the total market value (at today’s prices) for the assets you own. For example, if you have 5 lakhs invested in an equity mutual fund, and as the latest NAV, the value of these funds is 8 lakhs then the value of the HAVE column is 8
NEED is the present value of all of the goals
GAP = NEED - HAVE and is the amount you need to grow your portfolio by to consider your goals to be funded

We also have a TOTALs row to give a high-level view of the portfolio.

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Applying the HvN framework to the college goal

To simplify things, we assume that the child is 13 years old and college starts in 5 years. We will split the table like this:

Have vs Needs framework for college goal in 5 years

We need 30 lakhs for the college goal in 5 years and there is currently 20 lakhs created for the college goal of which five lakhs is in cash and 15 lakhs in equity. There is a retirement goal as well with a 75 lakhs corpus today.

The standard risk-management practice will be to sell down the equity portion of the college goal since the asset allocation for a goal that is five years is 0% in equity. However, selling that equity today will require paying tax unnecessarily. Here the HvN framework comes to the rescue.

The HvN framework says to:

allocate the 15 lakhs equity to the retirement goal
for the college goal, you can reach the remaining 25 lakhs cash via current salary (₹38,672/month) by investing in a short-maturity debt mutual fund
the remaining investible surplus (monthly income minus expenses) into the equity and debt buckets in that order

Some investors will object at this point and say, “but my child’s college goal money is not to be touched.” We are not doing that at all. We are optimising the allocation internally to minimise the taxes since we are not selling and buying at the same time for different goals.

What are the benefits of the HvN framework for this use case?

The following points illustrate the benefits of the HvN framework:

taxes are less since there are no unnecessary sells in the portfolio
the equity allocation gets an extra 5 years to grow instead of being built up via SIP over the next few years
the next few months or years of investments go into funding the goal that is due next
as salary increases, the cash bucket can be filled faster leading to peace of mind

Also read
The myth of the 15*15*15 or crorepati rule for mutual funds in India

What should you keep in mind before applying the HvN framework?

We have made some implicit assumptions while applying the HvN framework that we will now call out:

there is enough income between today and until college starts so that we can fill the NEEDs gap in the cash bucket solely via current income
the child will start college before the parents retire. If not, we need to fund the college goal before retirement starts. We have covered this point here: How should you invest for goals after your retirement or FIRE?

How to apply the HvN framework for college goals?

If you are using the Arthgyaan goal-based investing calculator, then it is effortless to calculate the numbers and use this framework as below:

Asset-wise view:

Have vs Needs framework plan bucket-wise

Goal-wise view:

Have vs Needs framework plan goal-wise

You can read more on the framework here: How to use the bucket theory to plan for your goals?.

What if the goal is due too soon?

In the example above we have assumed that the child is 13 years old and college starts in five years. There are over 50 combinations of teenage children’s ages (13-19) and time left until college starts if you include master’s degrees as well.

It is possible that there is not enough investible surplus left to fund the entire non-cash gap for the college goal via income alone. In that case, you should apply the rule to only a part of the equity surplus and rebalance the rest into cash. The SIP amount column in such as case will be higher than what you can invest every month.

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