The most important input while planning for a financial goal is the current cost of the future expenditure. When the goal is several years away, the current cost is a crude estimate. For retirement, we can assume present lifestyle barring child’s education expenses and liabilities. For a Ferrari, we can enter the current cost. For a world tour, we can enter the current cost. What current cost would be enter for our child’s education goal? The other goals are for us so we can make a reasonable estimate of what we want.
When our child(ren) are years away from college and have no idea what they are going to do with themselves, what current cost could we enter? That is the trouble with fixing the current cost of a child’s education.
The current costs of any financial goal can change from year to year. For example, due to ailment the monthly medical expenses can shoot up and this would affect the retirement goal and amount we need to put away for it. This is why a financial goal planner should be used one a year, every year.
Child’s education goal is problematic. The child’s desires can change widly as he/she nears school graduation. This could be because of developing individuality or peer pressure. Our estimates of the current cost of a child’s education can be significantly off as the child grows older.
Easier said than done, but we need to put our retirement planning first in the list of priorities at all times. So if X is the monthly investible surplus, and Y is the amount needed for retirement planning, at least 80% of Y should be allocated for retirement from Y.
Only the remaining (X-Y or at least X-80% of Y) can be spared for all other goals. Suppose my son is 2 years old and about 15 years away from college.
I can invest 60% in equity (12% returns expected) and 40% in fixed income (7% return post-tax).
Therefore the net portfolio return expected is (60% X 12%) + (40% X 7%) = 10%.
Inflation in cost of a child’s education: 10% (minimum). If you use more, you need to invest more. It is Diwali season, so let us no get depressed worried about actual inflation in education costs.
I invest (X-Y) each month for 15 years with a 10% return expectation. The corpus that I calculate
C = 12 * (X-Y) * ((1+10%)^15-1)/10%
is my current cost of my child’s education. You can use this Financial Goal Planner with Flexible Asset Allocation to plan and calculate for all financial goals.
Since income should increase each year (hopefully!), so should (X-Y). This can be factored in the above planner.
The main point of this post is, even those my son is only two years old, I set the current cost of my childs education now itself. This would be reviewed once a year, but I do not expect C to change dramatically.
This C is the amount that I would spend from my pocket to fund my child’s education. If my child aspires for something more expensive and/or if I am not wrong in my estimate of inflation (hopefully not return!), then the extra cost will be covered with an education loan. Related guest post: Paying off Education Loan in India
I cannot squash my child’s dreams by saying, “I can only afford this much’. At the same time, I cannot throw a spanner in my retirement plan and dip into it to make up for the shortfall.
This is of course for a normal, responsible child. If my child turns out to be a loafer who is not capable of putting in the necessary effort to match up to his aspirations, it would be a crazy idea to get him an education loan. So we will have to play it by the ear. Easier said than done.
Which is why I believe one should think hard before having a second child. Read more: Some Tough Personal Finance Related Questions
The danger with the education loan is the kind of salary that the child would get after graduation. That should be enough to start paying off the loan asap. Otherwise, I will have to pay the EMI. If I am still in service, perhaps that is not a big problem. If I am retired by then, my retirement plan could go for a toss.
Planning for a child’s education is not easy. As the child grows, we can discuss career options and suitably adjust the current cost to some extent as long as it is not too close to school graduation. Then there is the performance in the board exams, entrance exams, quality of college education (see below), reservations, our emotions, what the spouse has to say at that time (aka peace or lack thereof in the family) etc. Scary!