A simple calculation to invest right for your child’s future

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: August 30, 2023 at 6:00 am

It is the dream and responsibility of every parent to guarantee that our children have the freedom and ability to pursue their desired path in life. Additionally, it would be ideal for our children to begin their professional journey without the burden of an educational loan.

So it is vital that we strategically plan and invest in our child’s future. A straightforward calculation is presented here to assist you in this endeavour. Make it a priority to discuss this with your partner this weekend and accomplish this task!

One may ask which is more important—planning for a secure retirement or our children’s future. Emotionally this is an easy question to answer: Our children come first! See: Why our children’s education is more important than our retirement planning.

Especially if we become young parents and can work for at least a decade after they start school; however, both goals become equally important since couples are becoming parents in their early and mid-30s with tough corporate jobs. We will never take them seriously unless we sit and calculate how much investment will be made. That is why it is crucial to do this exercise as a couple.

What is presented is only a simple illustration. A more sophisticated, accurate and automated calculation is available in our robo-advisory tool for other goals, such as retirement.

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Step 1: Project current and current class (in school) into the future

Set up the following columns in any spreadsheet software of your choice. It will tell you when exactly you need the money for college. Or how many years you have to invest. Here it is for nine years

Investing for colleges expenses: Project current and current class (in school) into the future
Investing for colleges expenses: Project current and current class (in school) into the future

We also add the money available at hand, say Rs. one lakh in previous investments. We also assume you can invest Rs. 5000 a month or Rs. 60,000 a year. Here are assuming the girl will enter class four this coming academic year.

Step 2: Growth of the amount in hand

We assume that the Rs. One lakh in hand grows at about 7% post-tax a year, resulting in about 1.8 lacks after nine years.

Growth of the amount in hand at 7% a year
Growth of the amount in hand at 7% a year

Step 3: Growth of future investment amount

This step is crucial. Please increase the investment amount by at least 10% a year!

growth of investment amount at 10% a year this is a crucial step in investing for our child's future
growth of investment amount at 10% a year. This is a crucial step in investing in our child’s future

Step 4: Computing the value of monthly investments

To do this, we first need to know how much to invest in equity and how to invest in fixed income. We need an asset allocation. Alternatively, we can enter a yearly portfolio return, as shown below.

expected portfolio return for child future goal each year
expected portfolio return for child’s future goal each year

This corresponds to about 40% equity initially and 60% fixed income for the first three years, reduced to 20% in the middle three years and 0% in the last three years. This process (among others) is automated in our robo-advisory tool.

Where to invest this? I have made product suggestions in the video version linked below.

Step 5: Finding the final investment amount

Finding the final investment amount for college expenses
Finding the final investment amount for college expenses

In column G, we compute how the investments made each year grows with the corresponding annual return in column F. In column H, the total final value is shown. The yellow cell is the sum of two orange cells. See the video version if you want some help in computing column G.

Step 6: Finding what the projected corpus is worth today

Now we take the value in the yellow cell and devalue it by 10% (assuming inflation in education expenses) year after year to find the current value of the projected corpus. To ensure I do it for nine years, the cell in blue is devalued twice to get the current value.

Finding out what future college expense corpus is worth today at 10% inflation
Finding out what future college expense corpus is worth today at 10% inflation

So this means our future investments are worth about five lakhs today. If this amount is at least 70-80% of a college education today, the child will probably not need an educational loan.

The advantage of the above calculation is flexibility and a better understanding of what is going on and what has to be done.

Step 7: Choosing the investment products (watch the video version)

 

Step 8: Projections for a newborn (< 1-year-old) conservative

I have made two projections for a newborn with a full 17-18 years of time for investment. Even with a conservative return projection, the corpus is decent.

Projections for a newborn (<1-year-old) conservative
Projections for a newborn (<1-year-old) conservative

Step 9: Projections for a newborn (<1-year-old) aggressive

This is the same as above with a more aggressive return expectation (higher equity)

Projections for a newborn (<1-year-old) aggressive
Projections for a newborn (<1-year-old) aggressive

Weekend exercise

  1. Please do these steps with your spouse and let me know if it was useful
  2. What kind of asset allocation would you use for steps 8 and 9? Hint: How to reduce risk in an investment portfolio