Where there is a dream, there is a mutual fund way

Your mind races through wonderful possibilities as you look at the face of your bundle of joy, who is finally asleep after your patient efforts. In these rare quiet moments since holding your baby for the first time, you try to start planning for the future of your little one. Amid the interminable loop of nappy change, feeding and singing lullabies, planning smart investments may seem daunting. The good news is that, in mutual funds, young parents have a tool that can help them realise their dreams for their children.

Mutual fund advantage for young parents:

Many people are of the misconception that saving for children’s future is about saving for one need. The truth is that it involves being prepared for children’s many requirements ranging from emergencies, large expenses during primary, middle, and senior school followed by undergraduate and graduate studies and in most cases, marriage.  Mutual funds provide a long list of benefits to individual investors. These also help young parents wanting to save for their children.

Benefit from investment expertise:

Would you rather track the stock markets or record a video of your child walking for the first time? Your money along with that of millions of other investors is smartly invested by fund managers. They smartly manage risks with diversified investments, among other things, and put their expertise to use in growing your money. In other words, as you piggyback on the fund manager’s expertise, your child gets more time to piggyback on you.

Risk-based choice: Depending on risk-taking ability; you can choose among a wide-ranging of mutual fund categories. You can consider investing in low-risk money market funds or liquid funds besides short-term debt funds. Similarly, you can consider longer-term debt funds that invest in higher-risk debt securities.   Finally, you can invest in mutual funds that invest in varying proportions of equity and debt investments besides various types of equity funds, perched at the highest rung in the risk ladder, with potential for high long-term returns.

Different options according to the child’s needs:

Lesser the time available to meet your child’s needs, lower the risk you can take. Or, more distant the need, greater the risk you can take for higher returns. Thus, liquid funds and short-term debt funds are appropriate for needs likely to emerge within 18 months, with longer term debt funds being useful for needs arising in three-four years.   You can invest in mutual funds investing in a mix of debt and equity investments for requirements in five-eight years. For major long-term needs such as undergraduate and graduate studies, which are at least up to 10 years or more away, equity funds are appropriate.

Regular investments help:

Mutual funds help young parents establish a regular investment discipline, so critical for saving large amounts. With the help of regular monthly investments through Systematic Investment Plans (SIP), you can invest a predetermined amount, say Dh1,000, in a mutual fund. You can also opt for Top-Up SIPs where you can periodically increase the regular investment amount, say 10 per cent every year.

Allows parents to start small and save big: Young parents, typically, can only save small amounts early on. Mutual funds enable them to start with small investments for their child’s future and gradually scale up as pay and savings increases. This is a huge advantage when saving large amounts for children’s higher education as you need to give your money as much time as possible to grow with higher risk, higher return investments. Let’s take an example.

Assuming the UAE’s higher education inflation rate at 2.5 per cent  per annum. a four-year undergraduate course that annually costs Dh60,000 will rise to Dh93,579 after 18 years. With annual returns of 8 per cent, monthly investment of Dh194 should see you home. This amount will rise by almost 77 per cent to Dh343 if you start five years later, in case you feel more comfortable after annual pay hikes.   The other often under-appreciated advantage of small regular mutual fund investments relates to benefits from top drawer investments, especially in stocks. Thanks to pooling of money by millions of small investors in equity funds, a young parent can benefit from investments in stock market giants like Apple, Amazon, Microsoft, and Meta which he or she couldn’t have achieved individually.

Purges emotions from investing, helps retain focus:

Regular investments in equity funds besides providing typically high long-term growth, take emotions out of regular investments since you continue investing regardless of market conditions. This also helps you retain focus on your child’s needs even in periods of market turbulence.   In fact, SIPs help exploit market turbulence. You buy more units when the market is down and less when it is up, lowering the average cost of buying units in the long term. Consequently, you make substantial gains when markets rise in the long term.

Helps invest lump sums:

Even as you revisit your childhood thanks to your child, along the way there would be cash gifts presented to your child on occasions like birthdays and festivals. There would also be your pay hikes and bonus that can supplement regular investments with the help of Systematic Transfer Plan (STP) facility. Here, the lump sum amount is first parked in a very low risk money market fund or low risk, short-term debt fund. Then, predetermined amounts get regularly invested in a growth mutual fund investment like an equity fund.

Helps meet regular expenses:

According to a global study Value of Education–Higher and Higher by HSBC, a global bank, 74 per cent of young parents try to meet their children’s education expenses from their day-to-day income. This may mean trouble for other needs if the amounts are large such as sports equipment and training expenses besides test prep. For such situations, you need regular income from investments. Mutual funds address the need with Systematic Withdrawal Plans (SWP), where a predetermined amount is paid to you by liquidating units of your investments, typically in a low risk, debt fund.

Investing convenience:

Young parents can take advantage of easy availability of mutual funds. Apart from financial advisors, financial planners, and wealth management firms, you can buy mutual funds through banks and other financial institutions. Of course, you can also buy them online through online platforms.

Young parents’ mutual fund roadmap :

Before your child learns to walk or delights you with ungainly runs, you need to get going with investments for the child’s short-, medium-, and long-term needs. These investments for creating your child’s portfolio, need to start well before the child’s first birthday.

Enhance your emergency fund:

This is your “rainy day’ fund, equivalent to up to six months of expenses. With the birth of your child, increase the emergency fund and do an encore after the birth of your second child.    Apart from bank savings accounts and fixed deposits, a portion of the emergency fund needs to be parked in money market funds besides short-term debt funds. These mutual fund categories combine low risk with easy accessibility of money without any impact of prevailing market conditions. They typically provide slightly higher returns than alternatives. The portion of the emergency fund unlikely to be needed immediately in an emergency can be parked in mutual funds for the slightly better returns.

Make regular investments for school studies:

In Dubai, private school education has experienced significant growth in tuition and other costs in the past few years. Thus, it makes a lot of sense to start making regular monthly investments with SIPs in longer term debt funds so that savings is available for any upfront and other costs during primary school.   Among the debt fund investments, can be floating rate funds and dynamic bond funds. You can also invest in debt Exchange Traded Funds (ETF) where money is invested in debt securities in the same proportion as the index tracked by the fund. Besides debt mutual funds and debt ETFs offered in Dubai, expatriates can also consider offerings in their home countries. If you are already invested in debt funds, you can invest in the same funds while creating a portfolio for each child so that tracking their performance remains manageable.

Hybrid funds for middle and high school expenses:

As your child grows, shares her dreams, and excites you with her potential, there will be significant expenses from time to time. Equipment and coaching for games, hobbies and test preps are items that involve significant expenses. Regular investments in funds that invest both in a mix of debt and equity or hybrid funds, should help you prepare for such expenses. Again, if you have one or two hybrid funds in your portfolio, you can choose the same for your child.

Start investing for higher education:

Given the large amount of money required, growth investments need to start in the child’s first year itself. You need to opt for high-risk equity funds that typically provide high returns in the long term i.e., up to 10 years or more, after riding out the short run market volatility.

Invest in index funds and ETFs:

When it comes to pure equity investments, regular investments in index funds are often the simplest first steps. Index funds invest in stocks comprising the index they emulate such as S&P 500 in the US and FTSE 100 in the UK and invest in the same proportion as the index. Since stock indices represent the equities market, index fund investments are truly representative of investing in the market and give you a great chance of benefiting from the growth of any country’s most valuable companies and economy.

Like stocks, ETFs are listed in the markets where you can buy and sell them. In case of index funds and ETFs that track a broad index, thanks to their “passive investing”, fund management charges of the funds are very low and effectively enhance returns.

As your income and savings increases and you get used to negotiating the short-term market turbulence of equity funds, you can consider well-diversified, large cap funds. There are some other funds you could consider.

Consider multi-asset funds:

They invest in a combination of asset classes such as equity, debt, gold, real estate, among others. Diversified investments across asset classes help contain risks associated with one asset or investment class and ensure steady growth for your child’s savings during uncertain times like the one we are experiencing now. Such funds arguably have better growth prospects than so-called Children’s Plans, essentially hybrid funds offered by mutual funds, especially those in India and accessible to Indian expats.

Add target date funds:

These funds invest in a mix of assets and investment classes. The investments are rejigged to lower risk, as the target date, in this case, child’s higher education like undergraduate or graduate studies, approaches.

Invest in gold ETFs:

While this investment is not meant for a child’s higher education, it can be handy if you want gold investments for your child. Instead of buying physical gold, you could invest in these funds that track gold prices with each unit backed by a physical amount of gold, say 1 gram. If you plan to gift gold jewellery and accessories to your child on some special occasion years later, the sales proceeds of this investment will help you do so.    If securing your child’s future with investments is a long journey, mutual funds are an essential investment toolkit that help you manage any situation that may arise. They can not only help you empower your child to fulfil his/her promise but help you enjoy the parenting experience just like you want to.

Udayan Ray is a personal finance expert and founder, FundooMoney Media, an e-learning company working with India’s leading banking and financial services companies in the area of digital user experience content