Given rising inflation, a loan makes better sense

Before you realise, it’s the first day of school for your child. For a parent this is a big occasion, a child’s first steps down the long road of education. You have checked everything—uniform, pencils, crayons, books and schoolbag. Well, check again. Have you started a college savings plan for your child? 

If you feel there is still time, it may already be too late to start. Many financial planners would say that you are already late by five years. Following is a story that should set you thinking. Rohan is a zealous 18-year-old, fresh out of junior college, with an ambition to complete his engineering studies after which he plans to study management. Intelligent as he is, Rohan has secured admission at BITS (Birla Institute of Technology & Science), Pilani, a premier engineering institute, and plans to study further at IIM (Indian Institute of Management)-Ahmedabad, a globally-renowned management institute. However, the future of this student has hit a hurdle. In 2009-10, when he had set his eyes on BITS, the annual fee was Rs1.35 lakh. The fee for 2011-12 is Rs1.99 lakh; it has increased by over 21% in each of the interim two years. Therefore, Rohan would need over Rs10 lakh to cover his technical education. The fee for the management institute is no less; he would have to shell out over Rs14 lakh for two years. That has Ramesh, Rohan’s father, really worried. It’s not that he had not started saving for Rohan’s education. But he was not saving enough and not in the right way. Ever since Rohan was 10, Ramesh was investing around Rs36,000 a year in fixed deposits (FDs), earning him roughly 6.3% annually, post-tax. It has just dawned on Ramesh that his savings would fall short by more than Rs4 lakh to cover the fees for the entire course.

Thankfully, his wife Ronita, who had attended a financial literacy seminar, had started saving Rs500 per month as SIP (systematic investment plan) in a top-performing equity mutual fund (MF) around the same time that Ramesh had started saving. Her annual savings of Rs6,000 earned her a return of 12% amounting to Rs1.60 lakh. Sadly, their savings put together have fallen short by nearly Rs3 lakh, for which they would have to dip into their retirement corpus or take a loan. Had they saved in the reverse proportion, keeping 85% in equity, the need for a loan would not have arisen. Rohan has to put off his plans for management studies until he starts working and funds his own education.

This is an example but the figures are real. Between 1999 and 2009, even after adjusting for inflation, education expenses have increased by 162% in rural areas and 148% in urban areas, according to a National Sample Survey Organisation study. This means a 16% hike per year. For top-ranked private institutions, the inflation has been 20%+. You cannot plan to finance your child’s education with a low income-generating product like FDs. Financial planners tell you that you need to invest in equity MFs for the long term. There’s no investment product that would beat inflation in education costs; MFs come the closest. Insurance companies push child ULIPs (unit-linked insurance plans). Some of these are toxic; avoid them. Returns are low because of the ‘waiver of premium’ clause which comes at a cost. 

Our suggestion? Save as much as possible by putting a lot of money in MFs and some in FDs; but not for children’s education, especially if you have competing goals. If you are in the taxpaying bracket, take an education loan. Not only is the interest paid fully deductible under Section 80E of the Income-Tax Act, but those having a total annual income of less than Rs4.5 lakh can also avail an interest subsidy for the moratorium period on educational loans. Some banks even offer a 0.5%-1% interest concession for girl students.