How smart financial planning and taking them to a logical conclusion works
When you playact before your little princess, moving your outstretched hands like a bird flapping its wings, you know you will not fly. But when she does the same, you would not mind some magic. When it comes to securing her future, thanks to two unique challenges, only smart financial planning, and implementation over many years, works.
Costly education, getting costlier: First, higher education, your child’s biggest financial need, requires large savings to meet high expenses that are globally rising faster than general inflation. Life Insurance Bazaar, a Dubai-based financial planning services provider, estimates 6-9 per cent annual increase in tuition expenses over almost two decades. That is 1.2-2.1 times the general inflation.
The story is the same for overseas education in popular destinations for Dubai students like the US, the UK, and Canada. According to a 2020 study by McKinsey, a top global consulting firm, average cost for four-year undergraduate courses went up by 45 per cent during 2007-17.
In its recent white paper, Navigating the Changing World of Educational Finance, by MetLife, a global life insurance major, estimates an average US $16,290 (Dh59,784) in the UAE for undergraduate degree studies in private institutions for UAE citizens and non-residents. Of course, you need to save more for graduate and extended studies and in case you have more than one child. This is even as you grapple with rising costs for schooling in Dubai.
Critical need for protection: Second, your child needs financial protection in the eventuality of your untimely absence besides disruptions like temporary or permanent disability. This protection needs to ensure that the child’s immediate and long term needs like higher education are met.
In this backdrop, you need to take seven major steps to future proof your child.
1. Plan for both protection and growth
Get adequate protection to secure investments Your child needs adequate protection to ensure that investments for future needs, especially for higher education, are not used before time. Adequate life and health insurance along with disability insurance and emergency funds can ensure that. An adequate financial safety net ensures your child’s various needs like schooling and higher education are met not only in your absence but also in case of loss or disruption in income-earning capability from temporary or permanent disabilities.
Why balance protection with growth investments? Without adequate protection, in your absence, even with outperforming investments, your family will have to dip into them to meet regular and other expenses like outstanding loan repayments. This could mean your child eventually falling short of funds at crucial times, like at the commencement of higher education.
Get the early bird investment advantage: You need to be equally focussed on an early start to investments so that your money gets enough time to grow well. This is especially crucial for growth investments like equity and equity-oriented investments that typically need 5-8 years and more, to ride out short term turbulence and provide benefits of high long-term growth.
The twin focus of protection and growth also ensures that you do not have to fall back on loans like education loans or worse, dip into retirement savings in case you fall short of funds. Often, it is such loans and withdrawals that damage retirement preparedness.
2. Provide for adequate protection
In your child’s first year, even as you admire your bundle of joy from time to time, get started with your efforts to provide adequate financial protection.
Determine the life insurance amount: The right life insurance amount will not only take care of your family’s regular expenses and repay outstanding loans but also provide for a child’s major expenses like higher education. In early work life, you can get high life insurance coverage at an affordable premium from term insurance plans.
Get health and disability insurance: Expand your financial protection against health emergencies and income disruptions from permanent or temporary disabilities. You can do this with adequate coverage from health and disability insurance.
Build an emergency fund: For emergencies not covered by insurance, create an emergency fund. This “rainy day money,” typically three-six months of regular expenses, needs to be built over time. Typically, with the birth of your first child, your emergency fund requirements will rise, factoring in the possibility of emergency health expenses.
Periodically review protection: The level of insurance protection and the amount in the emergency fund needs to be reviewed periodically and upgraded, especially after life milestones. These are events like birth of a second child and enhancement in lifestyle thanks to a pay hike. You also need to have plans on how to continue with the protection during life transitions such as career switches and plunges into self-employment and entrepreneurship.
3. Ringfence financial protection
When it comes to providing financial protection to your child, no one wants a “slip between the cup and the lip.” Here is how to make financial protection fail-safe.
Ensure right nominees and beneficiaries Ensure that your child is covered by a health insurance plan. Determine your child’s guardian in your absence. Ensure that this person is listed as a nominee in all insurance plans and investments. Remember, it will be this individual who would collect death benefits from insurance plans earmarked for your child’s protection.
“Opt for the right death benefit payout”: Not every family has members equipped to manage large amounts of money from life insurance death and other benefits. This money must be managed to meet the child’s needs over many years. Choose among payout options such as lump sum, staggered and regular payouts for different time periods, according to your child’s needs.
“Draft a Will”: A Will, among other things, helps you earmark your financial investments and assets to your child and determines the child’s guardianship in your absence. A Will is not just for the high net worth individuals. It can play a key role in ensuring that a child’s financial protection such as life insurance death benefits do not get usurped by unscrupulous claimants. Given the tax and legal issues likely to be associated, consider involving an expert in drafting a document that will work.
4. Give your investments a head start
You need to get started with your investments before the child turns one. Here is how.
Get the big picture: Ask yourself when and how much money you will need for your child’s higher education be it undergraduate or graduate studies. This will help you arrive at savings and regular investment targets. Here is an illustration.
Fix savings and regular investment targets: Assuming the UAE’s higher education inflation rate at 2.5 per cent per annum, a four-year undergraduate course costing Dh60,000 will rise to Dh93,579 after 18 years. With annual returns of 10 per cent, monthly investment of Dh156 should see you home. Remember, more expensive the universities, delay in getting started and higher the expected inflation, greater the savings and regular investment needed.
Invest in growth investments: Equities have a history of being the most rewarding in the long term. Start investing in them with index funds. They 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. You gain when the markets rise. Next, consider well-diversified large-cap equity funds that invest in large and blue-chip companies.
Opt for regular investment: Regularly invest in mutual funds through Systematic Investment Plans (SIP). Start with the minimum SIP investment amount. Later, after pay hikes, consider Top-Up SIPs where your investment increases periodically, say, every year, by a predetermined percentage, say 10 per cent.
Consider children’s plans Life insurance children’s plans combine life insurance protection with investment. For high growth possibilities, consider equity-oriented options in Unit Linked Insurance Plans (ULIP). Besides features like premium waiver and payment of death benefit on demise, they may also offer staggered maturity payments suitable for the child’s higher education needs.
5. Maintain the growth momentum
After a head start to investments, maintain the growth momentum. Here are some steps that will help you.
Expand your portfolio: Explore higher risk investments like consistently performing international funds and thematic funds with appealing themes like blockchain and cybersecurity. Of course, restrict higher risk, higher reward investments to a small portion of your portfolio to ensure consistent returns without undue risks.
Supplement with lump sums: Supplement regular investments with lump sums from sources like cash gifts from grandparents and your bonus. For mutual funds, use the Systematic Transfer Plan (STP) facility where, after parking this money in a low risk, short term debt fund, regular investments are made in your existing equity fund.
Spread across asset classes: If you have 10 years or more left, consider other asset classes like real estate, investing directly, or through mutual funds. Similarly, consider gold investments, especially financial investments such as gold exchange traded funds (ETFs) and bonds. Portfolio diversification across asset classes ensures risks in one asset class does not adversely affect your overall returns.
Ensure adequate liquidity: Even as you pursue growth, provide for shorter term, big-ticket needs. These would be expenses during school years such as exchange programme visits, projects, and test preps. Here, debt funds and fixed deposits could be handy.
Rebalance your portfolio: Conduct annual performance reviews of your child’s portfolio. Check if risk levels have changed and determine corrective steps required. Often, investors lose sight of excess risk in their portfolio, especially in equities, after sharp market upturns. In such times, rejig your portfolio by reinvesting excess portions in the under-invested asset class.
6. Start preparing the money for use
About two-three years before you need the money for your child’s needs, rejig your investments to make them ready for use. Typically, these needs arise when your child turns 18, 21 and 25, something that can vary on a case-to-case basis. Here are a few important steps you need to take at this stage.
De-risk growth investments Time is now exactly right to start securing the gains from growth investments like stocks, equity, and equity-oriented funds. You can do this by gradually moving money out to lower risk investments like short term debt investments, be it short term debt funds, fixed maturity funds from mutual funds besides short-term bonds and fixed deposits. For mutual fund investments, this process becomes easier with Systematic Transfer Plans (STP), where a predetermined amount of money is regularly transferred to a lower risk fund.
Remember, this migration of funds should involve the money required for the upcoming requirement, say, for undergraduate studies. The remaining growth investments need to remain untouched. They can even be augmented depending on the timing of the next requirement like graduate studies.
Exit illiquid investments: Just in case you have illiquid investments in the portfolio such as real estate, this is the right time to exit and encash the gains. The same approach would work with physical or real assets besides alternative investments such as collectibles.
7. Smartly use your savings
One year before your child needs the money, take two major steps to ready your savings for use.
Customise for upfront, lump sum payments: These include upfront payments to institutions at Dubai or overseas, besides expenses related to housing, transport, and communication. Money from maturing children’s plans, be it lump sums or staggered payments, besides fixed maturity plans from mutual funds, bond maturity or sale proceeds and fixed deposits can meet these expenses. Then, there is money in short term debt funds and liquid funds from de-risked growth investments.
Create regular income: Monthly expenses such as housing, transport, food, books, communication, software, and other subscriptions need regular income flow. Systematic Withdrawal Plans (SWP) on debt fund investments can provide regular monthly amounts with the sale of equivalent mutual fund units.
Augment funds, liquidating lower return investments: To further augment funds, start with investments with the lowest returns, typically debt investments. Then turn to growth investments like stocks, equity and equity-oriented funds consistently underperforming over 18-24 months, or those with low or no upside potential. Avoid investments that will involve making a loss on exit or paying penalties and charges. Follow the same drill every time your child and other children need money.
Famous American comic fantasy writer Christopher Moore once said, “Children see magic because they look for it.”
The seven steps to future proof your child and fulfil her dreams also helps you lend a helping hand to her to not only keep seeing the magic but also create some.