Planning for kids college education (Part 2)
This is second part of the series on college education funding.
Have you read Part 1 of this article ?
3) Starting Late to Save & Invest
Some parents start saving for college education very late. This could be due to procrastination or due to under estimation of the college expenses or could be due to financial mismanagement. Anyway, it causes stress and hardship in last few years before the college year.
A family should start saving when the kid is 3-5 years old. Ideally speaking you need about 12-15 years of time for college saving. Unlike other financial goals like buying apartment or retirement, one can’t postpone the college admission by couple of years.
The strict timeline of the goal has to be kept in mind while planning. A kid need to go to college when they complete secondary education. No delay is expected. The inflexibility in the time horizon of college goal also cause other issues. That brings us to the next topic.
4) Picking Wrong Asset Allocation, choosing Wrong Products, and assuming incorrect Rate of Return of portfolio
You could be one of the several families that take kids education expenses seriously and hence budget properly. Even these families end up making mistakes in investments due to not seeking proper guidance from investment professionals.
“Do it yourself” works well for kids’ home science projects. The same method should not be applied to their own college educations planning. Lot of parents take financial planning for granted. Using the information from different magazines, they try to put their “knowledge” to work. Like first time cook, they end up “messing up” their finances and there is no second time for them. This reality dawns up on them too late.
Let me explain this in more detail.
First they pick wrong asset allocation, because they don’t understand the objective and reason behind asset allocation. They may build a portfolio with too much risk and less liquidity and end up having losing money in the goal year and not able to withdraw enough at the time of need. For example, investing all college education money in endowment insurance plan, buying real estate market etc.
On the other hand some investor may build a portfolio too conservative and end up short of their financial needs. Usually these portfolio is filled up with bank fixed deposits, post office deposits, company deposits, govt bonds etc.,
Either way, the selection of wrong asset allocation and wrong products cause more harm to the portfolio. ( I am not addressing the insurance plans sold by your distant relative “LIC Uncle” who said that plan should take care of “kids education”; what he really meant is his own kid’s college education expenses are taken care by selling that plan! )
Next they forgot to do “future-backward planning”.
[My friend/client Venky is a big proponent of this style of planning. I learned the word from him. thanks, Venky ]
What is future-backward planning ?
If your kid’s college education money is needed in 2018, you have to imagine yourself to be in 2018. You have to liquidate your portfolio and pay to college. Now decide what type of portfolio you should have in 2018, so it is easy for you to withdraw money and pay for the college. You will realize obviously you can’t have 100% of your money sitting in endowment plan or real estate or stock market.
Then step back one year to 2017 and see what portfolio you should have in 2017. Note the adjustments required. And repeat this steps until you end up in current year. Once you complete this exercise, it is not hard to realize the risk of the portfolio is going down year on year as we move forward and we must not ignore these adjustment to be made periodically.
Investor should also realize a portfolio that stepping down on the risky assets also is expected to have decreasing Rate of Return year on year. That is 2016 year return will be lower than 2015 year return and so on. Hence assuming uniform rate of return of 12% or 14% for the entire goal period, does not work. One will end up having lower accumulation compared to the target goal.
Why blame a “do-it-yourself” investor ? Even some financial planners are not knowledgeable enough to take care of such nuances and make adjustments.
A good financial planner can help in educating the parent and help in designing a proper asset allocation plan and help in choosing the right products to achieve those financial goals. What can we do for you ?[ Read Part-3 of this Article ]