How can you help your earning children to manage money more wisely

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There is no doubt that accumulation of substantial wealth occurs only over a sustained period of time. The best way to do it is the slow and steady manner, which your earning child needs to adopt in a disciplined way to accumulate the drops that will make a mighty ocean. The main question here is: which financial instruments to save in?

It has been statistically proven that it is not the timing of the investment but asset allocation — that is where all do you invest in and in what proportion — which matters the most in the long run. Wrong choice of instruments will do irreparable damage to wealth creation efforts while incorrect timings can easily be handled by regular investments in a disciplined manner over a long period of time.

Generally it is seen that, at least in the initial earning years of a young one, he/she is heavily dependent and influenced by his/her parents' pattern of investment. If the influencing parent is conservative and only goes in for safety of capital like provident funds, bank FDs, insurance policies and NSCs, the child also thinks along similar lines. However, the fact that these fixed-interest instruments are almost never able to keep up with the inflation monster, and consequently provide negative inflation-adjusted returns, is lost sight of.

Thus, while money may seem to grow in these instruments in absolute terms, its
purchasing power (or effective worth) is lost at a rate equal to the difference between inflation and tax-adjusted returns of the investment instrument. For example, if a bank FD gives 9% rate of interest and the child is in the 20% tax bracket (that is earning Rs 5-10 lakh a year), his/her actual returns on the FD are 9% minus 1.8% tax (20% of 9%), that is only 7.2% per year. With consumer inflation at around 9.5%, the money's worth is being lost at the rate of 2.3% per year on a cumulative basis.

The returns are likely to get further pruned in the current era of high inflation and falling interest rates as this 2.3% gap widens.

If the same money was to be invested in SIPs of equity diversified mutual funds, the long-term returns of the same are expected to be 12% per annum on a conservative basis while being fully tax-exempt according to current laws. Adjusted against inflation, it is likely to give 3% positive cumulative yearly returns on a conservative basis. Of course, one has to keep faith in the long-term returns potential of equity while not getting unnerved by the short-term equity-typical fluctuations.

Building an investment pattern similar to the one given in the table here is likely to provide your child a substantial accumulation of wealth in the future while still giving enough liquidity for any requirements in between.

Happy Investing!!

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Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax under Section 80C.

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Download Tax Saving Mutual Fund Applications

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