Arthgyaan

Supporting everyone's personal finance journey

What is the best way to invest for your child's college education?

This article shows you the right way to invest for your child’s college education with the result backed by historical data.

What is the best way to invest for your child's college education?


Posted on 07 Dec 2022
Author: Sayan Sircar
9 mins read
📢Join 3400+ readers on WhatsApp and get new post notifications!

This article shows you the right way to invest for your child’s college education with the result backed by historical data.

What is the best way to invest for your child's college education?

📚 Topics covered:

Introduction

This article will show you how to start investing for a college education degree in India or abroad by providing an actionable series of steps you can follow to reach a corpus for a college education.

We will draw upon the concepts built over previous articles on investing for children to demonstrate the efficacy of investing via capital markets to reach close to the desired corpus for college education.

Assumptions to be made

We will start with some assumptions at the beginning to get started:

  • College education cost will be 20x the investment in the first year
  • The degree will start 10 years from now
  • You will invest in mutual funds with a starting asset allocation of 60% in equity and 40% in debt and rebalance that over time

A question you will ask at this stage is why make these assumptions. To answer that, let us look at what information we have regarding the investment:

We know:

  • at what rate have prices increased in India, i.e. the general inflation, over the last 10-20 years
  • what the degree costs today
  • historical returns of asset classes like debt and equity

What we don’t know:

  • future general inflation as well as education-specific inflation
  • which degree and college will you finally choose
  • what returns will come from different asset classes

There are two things to do at this point:

  • nothing by going into analysis-paralysis mode
  • move forward by making reasonable assumptions based on historical trends and a process that you can follow

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

Step 1: Determine the cost of the degree

We will follow the process described in this article, How much will my child’s college education cost?, to estimate the cost of the degree today. We will also assume that the cost of this degree grows by around 9-10% a year over the next ten years.

At an inflation of 9%, a ₹10 lakh college degree cost will grow to around ₹24 lakhs in ten years. Using the 20x rule, the investment amount will be ₹1.2 lakhs or ₹10,000/month in the first year.

This SIP amount is increased by 10% per year over the entire investment period:

  • Year 1: ₹10,000/month or ₹120,000 that year
  • Year 2: ₹11,000/month or ₹132,000 that year (up by 10%)
  • Year 3: ₹12,100/month or ₹145,200 that year (up by 10%)
  • etc.
Start ₹ 10,000 / month
Investment ⬇️
Year 1 ₹ 120,000
Year 2 ₹ 132,000
Year 3 ₹ 145,200

and so on.

Step 2: Invest and review

We will start with a 60% allocation into equity and the rest into debt and reduce the equity allocation by 10% yearly. We have assumed collge fee inflation to be 9% and general inflation to be an average of the previous 10-year’s inflation. Equity and debt returns have been assumed as:

Equity returns over the next 10 years = general inflation + 3%

Debt returns over the next 10 years = general inflation - 2%

In the simulation, we have taken actual Sensex TRI return data for monthly returns and a fixed 5% annual return, which is in line with the returns from short-term money market debt funds, for the debt asset class.

We will rebalance based on a 5% corridor whenever asset allocation moves by 5% from the current target weights like this:

  • Year 1: allocation 60:40, rebalance anytime the allocation becomes 55:45 or 65:35, SIP amount is invested in the ratio 60:40
  • Year 2: allocation 54:46, rebalance anytime the allocation becomes 49:51 or 59:41, SIP amount is invested in the ratio 54:46
  • Year 3: allocation 48:52, rebalance anytime the allocation becomes 43:57 or 53:47, SIP amount is invested in the ratio 48:52
  • Year 4: allocation 42:58, rebalance anytime the allocation becomes 37:63 or 47:53, SIP amount is invested in the ratio 42:58
  • Year 5: allocation 36:64, rebalance anytime the allocation becomes 31:69 or 41:59, SIP amount is invested in the ratio 36:64
  • Year 6: allocation 30:70, rebalance anytime the allocation becomes 25:75 or 35:65, SIP amount is invested in the ratio 30:70
  • Year 7: allocation 24:76, rebalance anytime the allocation becomes 19:81 or 29:71, SIP amount is invested in the ratio 24:76
  • Year 8: allocation 18:82, rebalance anytime the allocation becomes 13:87 or 23:77, SIP amount is invested in the ratio 18:82
  • Year 9: allocation 12:88, rebalance anytime the allocation becomes 7:93 or 17:83, SIP amount is invested in the ratio 12:88
  • Year 10: allocation 6:94, rebalance anytime the allocation becomes 1:99 or 11:89, SIP amount is invested in the ratio 6:94

Also read
What are the best tax-saving ELSS mutual funds in 2023?

What does historical data tell us?

We have taken Sensex total return index (Sensex TRI) data from 1997 to create 192 simulations of investing for starting college after 10 years:

  • Simulation 1: Investing starts on 1st Jan 1997 and the last installment is invested on 1st Dec 2006 for admission anytime after 1st Jan 2007
  • Simulation 2: Investing starts on 1st Feb 1997 and the last installment is invested on 1st Jan 2007 for admission anytime after 1st Feb 2007
  • Simulation 3: Investing starts on 1st Mar 1997 and the last installment is invested on 1st Feb 2007 for admission anytime after 1st Mar 2007
  • and so on until
  • Simulation 192: Investing starts on 1st Dec 2012 and the last installment is invested on 1st Nov 2022 for admission anytime after 1st Dec 2022
(click to open in a new tab)
Success Ratio for investing for 10 years

The ratio success is defined in terms of the starting multiple. For example, someone investing in the year 2012 would be:

  • targeting 20.0x of the investment amount in the first year as the final corpus
  • will be investing for 10 years
  • will increase the investment amount yearly by 10% in line with salary hikes
  • invested on the first working day of the month
(click to open in a new tab)
Success Ratio for investing for 10 years as a chart

If they had followed the process, after investing for 120 months, they would have reached a corpus figure between 105-106% of the target, depending on which month they started. If they had invested ₹10,000/month in the first year, they would have reached, on average, higher than the 20.0 * ₹1.2 = ₹24 lakhs they set out to achieve. No case has fallen below 90%, which means that the model has been mostly successful, and any gaps, which would be small, can be bridged via educational loans. It is of course possible to invest more than 10% extra amount per year if you see that the portfolio is falling behind a lot but that will not be necessary as per this data.

Looking at the worst-case scenario from the past

(click to open in a new tab)
Impact of the global financial crisis on children's education

We look at a particular case where the investment was started in October 2005 and continued until October 2015. We will see the impact of the 2008 global financial crisis (GFC) on the portfolio, where the portfolio value briefly dipped below the invested value in early 2009. We will now zoom into the chart to see the actual impact of the GFC and how resilient the portfolio was during 2008-2009.

(click to open in a new tab)
Impact of the global financial crisis on children's education due to GFC

Due to the proper asset allocation, the impact of the equity market crash has been minimal for the portfolio, which recovered within a few months. The chart shows how the portfolio has excellent downside protection during market crashes that will be absent in a full-equity or fixed allocation (say 60:40 equity to debt) portfolio.

Conclusion

In this article, we have shown a process to be followed for investing for children’s college corpus by investing in two asset classes (equity and debt). We have shown how the portfolio is constructed using historical inflation data without any further assumptions and is managed for ten years using a glide path that systematically lowers the risk exposure of the portfolio as the college admission date comes closer. We have also shown that over the last 26 years, the process has been successful in getting over 90% of the target in all cases. If you are a parent looking for investing for college education, you can follow this process. This is the complete sequence:

Related Articles

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

For resident Indians 🇮🇳:


For NRIs 🇺🇸🇬🇧🇪🇺🇦🇺🇦🇪🇸🇬:


Share on WhatsApp:

To understand how this article can help you:

If you have a comment or question about this article

The following button will open a form with the link of this page populated for context:

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Previous and next articles:



Latest articles:



Topics you will like:



Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.

More posts...

Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled What is the best way to invest for your child's college education? first appeared on 07 Dec 2022 at https://arthgyaan.com


We are currently at 499 posts and growing fast. Search this site:
Copyright © 2021-2024 Arthgyaan.com. All rights reserved.