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Mutual funds offer ease of investing, transparency and tax efficiency. Use them to invest in stocks, debt and gold.

You must have heard this at least a hundred times: equity mutual funds are the best way to create wealth over the long term. Are small investors listening? It doesn't seem so. According to the Association of Mutual Funds in India (Amfi), retail investors do not stay invested long enough in equity funds to realise the potential of this asset class. The average equity fund investor stays with it for only 18 months. Nearly 38% of retail investors exit equity funds before they complete two years.

Investing for your child's long-term needs requires a lot more discipline than this. More importantly, the investor should not lose sight of his longterm goals due to short-term market volatility. During the market mayhem of 2008-9, many small investors discontinued their SIPs in mutual funds. Some even withdrew their investments. "It is unfortunate that these investors would have continued with their Ulips as there was no way to exit them. Mutual funds became victims of the liquidity they offered," says Arindam Ghosh, head of retail sales, JP Morgan Asset Management.

The child plans launched by mutual funds are an attempt to inculcate long-term investing discipline in parents. "If you have invested in a fund called a child plan, you will think twice before withdrawing from it for discretionary spending," says financial planner Gaurang Gandhi. As studies have shown, it pays to keep your investments locked away for the long term. If you had invested 10,000 in the HDFC Top 200 Fund 10 years ago, your investment would be worth 1.6 lakh today. An SIP of 5,000 started in the Reliance Vision Fund in May 2001 would have been worth over 27 lakh today. "An SIP in an equity fund is the best way to invest for the long-term needs of your child," says Ritesh Jain, head of investments, Canara Robeco Mutual Fund.

Child plans also help earmark funds for specific goals, dividing the portfolio into several categories. This makes it simpler for a parent to monitor the investment for a particular goal and take corrective steps if the growth does not match the expectations. As we explained earlier, this segregation is important because each goal has a different time frame and, therefore, requires a different investment mix.

Fund houses have customised their schemes to suit the desired asset allocation at various stages of the child's life. Fidelity Mutual Fund has three schemes for children, each with a different asset allocation and aimed at different investors. The parents saving for their child's higher education can opt for the Fidelity India Children's Education Fund, which invests 70% in stocks and 30% in debt. The Children's Marriage Fund has a similar equity exposure, but also invests 10% in gold. The Children's Savings Fund, which has 100% in debt and money market instruments, is aimed at conservative investors or those nearing their financial goals.

The tax efficiency of mutual funds, especially debt-based schemes, makes them an ideal long-term investment vehicle. When you invest in a fixed deposit for your child, the taxman treats the income as your earning (see page 17). But when you invest in a mutual fund, there is no tax implication till you redeem the investment. So, if you invest in your child's name, you can defer the tax for years. If the money is withdrawn by him after he turns 18, any profit will be treated as his income, not yours. After such a long period, the indexation benefit (which takes into account the inflation during the investment tenure) would reduce the tax to nearly zero.

Before you buy

Ask a child his favourite ice-cream flavour and he is likely to say chocolate. Or butterscotch. Or even tutty fruity. Nobody likes plain vanilla. But when you invest in mutual funds for your child, plain vanilla funds could be more rewarding than the schemes aimed specifically for children. "An investment for your child should not necessarily be in a 'child plan'. Any fund can be a child plan if it fulfils the basic need to grow wealth," says Dhirendra Kumar, CEO of Value Research. The performance report card of child plans is a mixed bag. Some have done well, but quite a few have lagged. HDFC Children's Gift Fund-Investment Plan, an equity-oriented balanced fund, has done very well in the past three years, with 18.2% returns. But its 5-year returns of 12.6% are not too impressive, and pale in comparison with the 18% churned out by HDFC Prudence, a long-term winner from the same fund house.

Similarly, ICICI Prudential Child Care-Study Plan is the best performing child plan among the debt-based balanced funds, with 10.7% returns in the past three years, and 9.99% in the past five years. But Reliance MIP, which also has 20% invested in equities and, therefore, has almost the same risk profile, has earned 15.8% in the past three years and 11.33% in the past five years.

Mind the exit load

There's something else you should know before you buy a child plan. To make parents remain invested for the long term, these plans levy stiff penalties on early redemptions. After the removal of entry loads, fund houses had started levying exit loads of around 1% if the investor withdrew before a year. In the case of child plans, the penalty is as high as 4% and the minimum period can extend up to 5 years. For Tata Young Citizen's Fund, there is a 1% exit load even if the investment is redeemed after 7 years.

However, this should be seen as a positive feature rather than a problem. "The exit load is a good deterrent against early withdrawals. It promotes long-term growth," says Dhirendra Kumar. The Templeton Child Asset Plan is the only scheme which does not levy an exit load.

Why debt funds are better than FDs

The high rates being offered on bank deposits are very attractive. One would think it was the right time to lock in for the long term. But very few banks offer long-term fixed deposits. For most, five years is the longest tenure; some offer terms of up to 7-8 years. The 10-year deposits being currently offered by some banks are rare. Moreover, the rate is usually lower than that offered on 5-7-year deposits. "Long-term deposits are just not available. Few banks want to take the risk in an uncertain rate regime," says Ritesh Jain, head of investments, Canara Robeco Mutual Fund. If you want to invest in a safe debt option for the long term, income funds are a good substitute. These invest in bonds and corporate deposits, thus benefiting from the high interest rates. "Though such deposits provide a fixed return, the investor is unable to benefit from the movement in interest rates," says Jain. The Canara Robeco Income Fund has given scintillating returns of 13.5% in the past three years.

Debt funds do away with the need to renew fixed deposits or search around for the best rate. The fund manager does that for you, thus reducing the interest rate risk. They also offer liquidity because unlike fixed deposits, an investor can get out of a debt fund without any penalty.

Source : ET