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.
This article shows you the right way to invest for your child’s college education with the result backed by historical data.
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.
We will start with some assumptions at the beginning to get started:
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:
What we don’t know:
There are two things to do at this point:
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:
Start | ₹ 10,000 / month |
---|---|
Investment ⬇️ | – |
Year 1 | ₹ 120,000 |
Year 2 | ₹ 132,000 |
Year 3 | ₹ 145,200 |
and so on.
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:
We have taken Sensex total return index (Sensex TRI) data from 1997 to create 192 simulations of investing for starting college after 10 years:
The ratio success is defined in terms of the starting multiple. For example, someone investing in the year 2012 would be:
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.
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.
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.
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:
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Published: 8 December 2024
7 MIN READ
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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