How to Start an Investment Portfolio for a Child?
Enabling your kids to face the future with confidence is not easy, especially when the cost of education and the cost of living is experiencing an exponential rise. Hence, financial planning for a child’s future, education, or wedding is on every parent’s priority list. Moreover, saving for your kid’s future needs requires utmost care rather than being an ad-hoc decision-making activity. You must prepare to meet your child’s financial needs at different stages of their life. Moreover, an early start is ideal for creating a sizable corpus using the power of compounding to the hilt.
Look for investment options in market-linked instruments and supplement with low-risk avenues like fixed deposits and PPF to build substantial savings. Your risk tolerance is an essential factor driving your choices about how to open an investment account for the child. So, here are a few investment tools and products to consider for your child’s potential long-term needs.
Different Types of Investment Accounts for Kids
Simply setting aside a sum of money every month in disparate investment vehicles may not bear fruit. Your investment must grow. Keeping pace with inflation is necessary, as it can play the spoilsport if ignored. For instance, the cost of an engineering course at ₹4 Lakhs will rise to ₹10 Lakhs after 16 years, considering the annual inflation of 6%. So, with an estimated growth of 15% per annum, you will need to set aside ₹1,300 per month to reach the target.
Similarly, a 2-year MBA course today at ₹11.5 Lakhs will need ₹40 Lakhs after 21 years with the same inflation rate. Thus, you will need to invest ₹2,233 per month with a 15% annual compounded growth to reach the sum.
So, the stepping stone to opening an investment account for a child’s future is to set clear objectives with defined future goals. Next, build the portfolio with diversified asset allocations to deliver the expected future value in the appropriate time horizons. With the above insight in our minds while venturing for a child investment programme, let us look at the available investment vehicles that could lead to your desired outcome.
We have compiled a list of four of the best investment options that qualify to meet the future financial needs of your child. The first two are Sukanya Samriddi Yojana (SSY) and the Public Provident Fund (PPF) account under the government-sponsored small savings category, with long-term investment horizons. The third plan is investment in Equity Mutual Funds and the fourth one is investing in Sovereign Gold Bonds (SGBs). Let us dig a bit deeper into the types of investment accounts for your child.
The first two, SSY and PPF accounts, are fixed-income schemes with definite lock-in periods. But they provide higher interest rates than many other traditional investment vehicles in the market such as Fixed Deposits. In addition, these child investment accounts are reliable and safe due to the Government’s sovereign guarantee. Equity Mutual Funds, on the other hand, provide market-linked returns in the long-term that essentially match your goal of inflation-adjusted returns. SGBs are good substitutes for physical gold and are considered a safe investment option offering decent returns. Thus, combining the four appears to be the ideal solution for securing your child’s financial future. So, let us study each of them in greater detail.
Also Read: Best Child Plans Mutual Fund in 2022
SSY (Sukanya Samriddhi Yojana Account)
This wealth management plan is a social welfare initiative brought forth by the Government that targets the girl child to meet her financial need for education and marriage. You can open the SSY child investment account with any post office or bank to secure your girl child’s future. The salient features and benefits of the investment scheme are:
- The girl should be under 10 years to open the SSY account.
- A girl child can open only one account, with a limit of two per family.
- The SSY account shall be operated by the girl child’s guardian till she attains the age of 18. After that, she can operate the account herself post submission of necessary documents.
- The account matures after 21 years from the opening date, regardless of the account holder’s age. However, you need to contribute for the initial 15 years only, and the account continues to earn interest until maturity.
- The minimum deposit to open the account is INR 250, but you can contribute up to Rs. 1.5 Lakhs annually.
- The current applicable interest rate is 8.0% per annum with annual compounding.
- A window of partial withdrawal opens as the girl turns 18. Thus, the account holder can withdraw up to 50% of the previous year’s closing balance for her higher education. However, she must have cleared the 10th standard exam to be eligible.
- The parent can request for premature closure of the account upon the girl’s marriage after she turns 18. The parent must provide an affidavit stating that the girl is not below 18 years of age on the wedding date. This is subject to change now for the closure of the account to be 21 years as per the Government of India’s new policy of age limit for marriage for girls to be raised to 21 years of age.
- The SSY account enjoys an “EEE” income tax status enjoying exemptions throughout the investment cycle. So, the investment, interest accrued, and maturity values are all tax-free, and subject to compliance with the underlying rules.
Also Read: Best Investment Plan for a Child’s Future
Public Provident Fund (PPF)
It is one of the oldest long-term government-sponsored investment vehicles and has been popular among taxpayers for a long time. The account is flexible and consistently delivers higher returns, besides tax-saving benefits. Here are the account’s salient features and benefits.
- You can open a PPF account in a post office or commercial bank branch.
- Resident Indians above 18 years of age are eligible to open the account in self-name or on behalf of a minor. However, no one can hold more than one account.
- The initial deposit is INR 500, but you can contribute up to INR 1.5 Lakhs per year. However, the minimum amount to keep that account active is INR 500 annually.
- The account matures after 15 years, but you can extend the tenure in 5-year blocks and continue contributing to building a corpus.
- The current interest rate payable to the PPF account is 7.1% per annum with annual compounding. The PPF(Public Provident Fund) interest rate is reviewed by the Government every quarter.
- You can withdraw partially after 5 years, excluding the account opening year. The amount payable is 50% of the previous year’s balance.
- Premature withdrawals are allowed after the completion of five years from the end of the year in which the initial investment was made. If you started your PPF account in February 2012, you can make partial withdrawals from the financial year 2017-18. However, you can only withdraw either 50% of the balance at the end of the fourth financial year or 50% of the balance at the end of the preceding year.
- You can avail of a loan from the PPF account, subject to complying with the underlying conditions.
- The PPF account provides a significant tax-saving advantage following the exempt-exempt-exempt (EEE) regime that covers the entire investment cycle. While you can claim a tax deduction up to INR 1.5 Lakhs in a financial year subject to your contribution under Section 80C of the IT Act, 1961, the interest accrued and the maturity values are tax-free.
Also Read: How to Open a PPF Account for Minors?
Children’s Gift Mutual Funds
These types of mutual funds are positioned at funding various life events of children such as higher education and marriage. Children’s Gift Mutual Funds are mostly hybrid, meaning that funds are invested in both debt and equity instruments. The distribution of the funds further depends on the risk-taking appetite of the parent. Investments in these funds can be made only in the name of the minor child.
- Children’s gift funds generally have a lock-in period of 5 years or until the child becomes a major, whichever is earlier.
- Parents or legal guardians are allowed to invest in these funds on behalf of their child.
- If you have a long-term investment horizon and adequate risk tolerance, equity-oriented schemes have the capacity to generate significant returns. In contrast, debt-oriented funds offer more or less stable returns in comparison to equity funds.
- As these mutual funds generally have a minimum lock-in period of five years, premature withdrawals come with a high penalty in terms of exit load.
Sovereign Gold Bonds (SGBs)
Gold investment has always been a popular choice among Indians. However, buying and storing physical gold comes with its own set of risks. To ease out the process of gold investment, the Government launched Sovereign Gold Bonds (SGBs) in 2015. SGBs are debt instruments that are issued by the RBI (Reserve Bank of India) on behalf of the Government. They are denominated in gold and you only have to pay the issue cost in cash (up to a maximum of Rs. 20,000/-) or demand draft or cheque or electronic banking. On maturity, you will receive the market value of gold at that time. Further, it offers returns at a fixed interest rate of 2.5% p.a. (paid semi-annually). Following are some features and benefits of SGBs:
- The minimum investment allowed is 1 gram of gold, while the maximum limit is set at 4 Kg for individuals and HUFs.
- SGBs are government-backed. Hence, you don’t have to worry about losing your capital
- All Indian citizens are eligible to invest in Sovereign Gold Bonds. Guardians can invest on behalf of minors.
- The maturity period of gold bonds lasts eight years. However, early encashment/redemption is allowed after five years from the date of issue on coupon payment dates.
- The interest you receive through SGBs is taxed as per your existing tax slab. However, the capital gains component on redemption is tax-free if the SGB is held for 8 years.
- If the bond is redeemed after 5 years, but before the completion of 8 years, then your gains will attract LTCG (Long-term capital gains) tax at 20% along with indexation benefits.
- The issue price of the Gold Bonds will be Rs. 50 per gram less than the nominal value if you apply online and make the payment through digital mode.
The best investment account for the child should reap the maximum benefits from the estimated monthly savings. So, devise a strategy to achieve the target for your child by dividing the investments between SSY, PPF, and an array of Equity Funds to distribute your investment. Also, factor in your risk profile while choosing an ideal combination without banking on a single window. While the SSY and PPF are debt investments, they have a fixed tenure with a lock-in clause. Contrarily, open-ended Equity MFs provide you with the flexibility to focus on reaching the objective.
Frequently Asked Questions
How do you sustain a strategy after knowing how to open an investment account for the child?
Simply knowing how to open an investment account for the child is not enough to reach the desired objective for your child’s future financial needs. It is important to review the investments periodically, especially the equity funds, to determine if a course correction is necessary and if further diversification and funds transfer needs to be adopted. Moreover, consider seeking the advice of a SEBI-registered professional to devise a strategy, and help choose the right product mix to create a corpus and reach the goal.
Are there any products matching the properties of Equity MFs to consider as a potential child investment account?
ULIPs are among the many products that closely match the properties of equity mutual funds, but there are differences too. ULIPs are life insurance products that cover your life risk while providing the benefits of investments. So, the returns are higher from the asset allocation in market instruments in a product mix aligned to your risk profile. In addition, the initial 5-year lock-in constricts your flexibility in creating your investment portfolio. Consider the ULIP when you do not have life coverage for your family as a good alternative.
How are the applicable interest rates in SSY and PPF accounts determined?
Since the SSY and PPF accounts are government-sponsored, the Ministry of Finance reviews the applicable interest periodically. Accordingly, the Ministry of Finance notifies the applicable rates every quarter of the financial year, valid until the quarter ends. Consequently, the standout feature of the mechanism is that the rates are consistently higher than other investment instruments.
Are minors allowed to invest in mutual funds?
The parent or guardian can open a mutual fund portfolio in the name of a minor. However, the account should be single, as joint holding with a minor beneficiary is not permitted. Moreover, since the minor beneficiary cannot make financial decisions, the parent or the guardian becomes the account’s custodian until the minor beneficiary attains majority.