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Better to choose equity funds in a child's early years and shift to debt later

Childcare plans run by mutual fund houses have given an average 11% return on a compounded annual growth rate (CAGR) basis in the past 10 years.

This may seem more attractive than traditional investment avenues such as public provident fund and fixed deposits. But analysts say investors would be better off investing in diversified equity funds in the early years of a child plan and increasing exposure to debt funds in the later part to make the most of such schemes. Some child plans have done well. Investing in a child plan is similar to investing in a normal open-ended mutual fund. It is also important to check the asset allocation a fund maintains and whether it would be suitable for your risk profile and for meeting your long term objectives.

 
There are 10 childcare schemes offered by top fund houses such as HDFC, ICICI, SBI, Templeton, UTI, Peerless and LIC Nomura. According to Morningstar India, these funds can be broadly classified into three categories — conservative allocation, moderate allocation and equity funds. In conservative allocation, the asset allocation is similar to monthly income plans with 20% allocation to equities. Plans such as HDFC Children's Gift Saving, ICICI Pru Child Care Study Regular Plan and SBI Magnum Child Benefit Regular Growth, in existence for 10 years, have given an average 7.2% return on a CAGR basis. In this category, Peerless MF Child Growth scheme, running for less than 10 years, has given 8% returns in the past three years. It offers some exposure to gold, too.

In the moderate allocation category, childcare schemes such as HDFC Children's Gift Investment, LIC Nomura MF Children, Templeton India Children Gift Growth and UTI Children's Career Balanced are similar to balanced funds and have around 60% of asset allocation to equities. This category has given average returns of 12.4% in 10 years. Schemes in the third category have 100% asset allocation to equities. Schemes such as UTI CCP Advantage Growth and ICICI Pru Child Care Gift Regular Plan have fetched returns close to 16% in the past 10 years.

To make the most of their investments, investors should understand the tax implications of the schemes. While choosing these funds, an important thing investors should note is asset allocation. If the fund invests more than 65% in equities, then investment made in such a fund is exempt from capital gains tax provided it's held for one year. And if the fund invests less than 65% in equities, the investment is taxable at a rate lower of 20.6% with indexation and 10.3% without indexation. Purely, from the tax efficiency point of view, schemes with more than 65% exposure to equity are best placed for investors who remain invested for more than one year. However, if one is not keen to take risk associated with equity investing, it makes sense to go for the other options.

Most analysts say the best way for parents to approach investing for their children is to adopt a systematic approach of high exposure to equity in the formative years of the child and increasing exposure to debt funds in the later part of the investment horizon. For instance, if parents plan a 15-year investment for their children, analysts recommend having exposure to diversified equity funds for the first 10 years and then gradually increasing exposure to debt funds in the last five years. This works for parents who are conversant and well-informed about investing in markets. But, for those who are occupied in their jobs and have little time for investments, investing in childcare schemes with high equity exposure can fetch reasonably good returns, say analysts.

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