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Should you invest in stocks, mutual funds, PPF and Sukanya Samriddhi for children?

Posted on 17 Oct 2021
Author: Sayan Sircar

Tags: Choosing Investments ; Children

12 mins read
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This post will help parents to cut through multiple confusing product choices to get started with investing for their children.

Should you invest in stocks, mutual funds, PPF and Sukanya Samriddhi for children?

📚 Topics covered:

Introduction
Child insurance plans
Public Provident Fund (PPF)
Sukanya Samriddhi Yojana (SSY)
Direct stocks
Mutual funds (MF)
Bank deposits (FD/RD)
Gold and jewellery
Real estate
How to estimate the SIP value for children’s goals
Putting it all together
A note on having the prerequisites in place

Introduction

We have already covered before how having too many product choices prevent people from getting started with investing.

With the psychological factor of investing for children for whom we want only the best, getting started becomes a big problem. The only thing that can stop our children from fulfilling their dreams is a lack of financial planning today. Goal-based investing can solve this problem.

We will take the following three-step framework to solve this:

set the goal: why to invest, when the money is needed, and how much is the cost. This has been covered in detail in this post
decide where to invest and how much (this post you are reading)
perform yearly review and rebalancing as per your glide-path

This post goes through a few investment product options and uses the RRTTLLU framework to consider suitability. A key consideration when choosing investment products is the beat the high inflation (10%+) associated with goals like a college degree.

Inflation: the impact on your goals and how to choose assets that beat it

The list below is not exhaustive, but it will suffice for most situations that involve goals like college education (UG/PG) and marriage.

Child insurance plans

We start with this example to demonstrate how something labelled as suitable for children is absolutely the wrong product to choose for most people. These plans have names with the words child, scholar, kid etc., in them. These are traps for parents to waste their money since they give poor returns that are insufficient for children’s goals. Currently there is no special buy-and-forget plan offering in the market that offers a balance of high returns with low risk.

Children do not need insurance since they do not earn. Parents need term life insurance so that their children’s goals can be funded in case of their death. Term insurance is the only insurance product that should be purchased. Once the child’s goals are discovered, parents should top up their existing (or take new) term policies.

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Public Provident Fund (PPF)

PPF allows you to invest ₹1.5 lakhs/year in every family member’s PPF account (grandparents, parents, children) and allows ₹1.5 lakhs exemption/year under section 80C per investor. So a family with goals that are far away can invest 1.5 lakhs/year for multiple family members as long as their asset allocation allows it. The interest rate for PPF is 7.1% today and is expected to fall with time. The money is locked until maturity for 15 years. The returns of PPF, although guaranteed, are well below inflation applicable to education goals and only PPF investing will not suffice on its own.

PPF thus has three significant risks: fluctuations in interest rate, low returns and lack of liquidity.

The issue here is that money is locked for 15 years that prevent you from rebalancing from debt to equity when stock markets fall. To know more about why rebalancing is important, read this post.

Sukanya Samriddhi Yojana (SSY)

SSY is allowed only for girl children (Indian resident parents only, NRI is not allowed) and has a ₹1.5 lakhs/year limit for investment. It offers a tax deduction under section 80C and has a 7%+ interest rate as of today. The amount is locked in until 21 years from account opening date and allows partial withdrawal once the child is 18. It is recommended that SSY is used mainly for goals like post-graduation degree and marriage due to the lengthy lock-in. However, if your monthly investment amount is high enough, SSY can also be used for retirement planning.

It is expected that over time, as the Indian economy matures, these debt instrument returns (like SSY and PPF) will go down. Invest in them only if the product maturity aligns with the goal maturity (PPF is 15 years and SSY is 21 years) and you have enough in liquid debt instruments to rebalance. The returns of SSY are also well below inflation applicable to education goals and will not suffice on its own.

SSY, like PPF, thus has the same three risks: fluctuations in interest rate, low returns and lack of liquidity.

Direct stocks

Buying individual shares requires considerable time and effort to analyse and pick stocks. If you have a full-time job, it may be challenging to devote the necessary amount of time to research and pick stocks. As we have argued before, if you invest in direct stocks, it is good to benchmark that frequently. Most investors do not need to directly invest in individual stocks for children’s goals.

Mutual funds (MF)

Mutual funds give you the option to get your money managed by a professional asset manager without you having to track stocks markets, bonds markets and the overall economy. Equity mutual funds are recommended due to their potential to beat, over long periods of time, the inflation associated with children’s goals. Similarly, debt mutual funds will need to be a part of the asset allocation to complement the fluctuations of equity and manage the overall risk via rebalancing.

Once you start investing in mutuals funds, the only thing you need to do is a regular review of your funds and the progress towards your goals over time.

This post will show how to choose suitable debt and equity MFs to create a portfolio for your children’s goal.

Also read
SGB issued in Feb 2016 has given 141% return in 8 years. How does that compare with FDs and equity mutual funds?

Bank deposits (FD/RD)

Fixed deposits offer a known interest and principal amount at the time of opening the FD. They are the only product that has this feature. All others are market-linked, and the return is unknown. There is a deposit guarantee insurance for money kept in banks up to five lakhs per bank. However, there is no timeline as to when the funds will be received if a bank fails. If you need absolute safety, stick to RBI’s list of Systematically Important banks, currently SBI, HDFC and ICICI.

Bank deposits are taxed at your highest tax rate (say 30%), and post-tax, the return is much lower than inflation. Most investors should avoid them except for the case below:

Given how taxes work for debt mutual funds, if a goal is within three years, it should be saved in bank FD/RD solely because the final value of the FD is known, and taxation will be the same.

Gold and jewellery

Gold in physical form and jewellery is primarily used for weddings. Parents generally wish to accumulate a fixed amount of gold yearly for marriage purposes. However, apart from gifting, gold or jewellery cannot be used for paying for the cost of the wedding and functions. Nor can you use it for purposes like paying college fees.

Hence invest in gold only after you have invested enough in other options. Gold can be a way to transfer wealth to children but is not suitable for goals like a college education.

Real estate

If you already own the house, you can plan to use it for the goal, provided you can sell it on time. Goals like college education have to be funded on a specific fixed date, and it may be not easy to sell the house at the desired price by that date. Real estate, like gold, may be more suitable for leaving wealth to children than for meeting financial goals. Generally buying a house on EMI, for children’s goals, should be avoided.

How to estimate the SIP value for children’s goals

We will use the comprehensive Goal-based investing tool to calculate the SIP amount needed.

Putting it all together

We will assume yearly rebalancing and asset allocation as below:

Goals beyond 15 years (like UG college)

Asset allocation:

60% equity mutual funds
20% PPF
20% debt mutual funds

Goals beyond 21 years (like PG/PhD/marriage/first house)

Asset allocation:

60% equity mutual funds
20% debt mutual funds
20% SSY (for girls), PPF for boys

Goals within 15 years but more than five

Equity mutual funds up to 60%
Rest in debt mutual funds
Some PPF/SSY is possible if maturing within that period
Reduce the equity allocation via rebalancing to zero by the time five years are left

Equity allocation will be as per this formula:

E% = (Y - 5) * 6% where Y is the time left in years. This formula shows, for example, that if the college starts ten years away, the portfolio should have 30% in equity and the rest in debt.

Goals within five years

No allocation to equity
PPF/SSY possible if maturing within that period
Mostly in debt mutual funds

Where to invest

Equity mutual funds: here
Debt mutual funds: here
PPF, SSY
bank FD/RD if the goal is within 3 years

Read more on operational aspects of investing here: Should you invest in the name of your children?

A note on having the prerequisites in place

At all times, ensure that you have the following in place

An emergency fund with 6-12 months of expenses
A term insurance policy (unless you are retired with no income)
A health insurance policy (separate from the company-provided one, if any) for 10-15 lakhs as a base policy with a 50-100 lakhs super-top up
A personal accident insurance coverage to safeguard against accidents where you do not die but cannot earn
No high-interest debt like credit card or personal loans

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