Every parent wants the best for their child. From the time they first hold their newborn in their hands - and often even before that - most parents spend a great deal of time dreaming about the major milestones in their child's life. To fulfil these dreams and goals, though, parents need a comprehensive financial plan that states not only what you should do but also what you should not do. That way, you can avoid the costly mistakes that many parents often inadvertently make.
Here are 7 mistakes that you need to avoid.
1. Delaying your investments
Needless to say, this is one mistake that a vast majority of parents are guilty of. Many people put off investing for their child's future and only think about it when their child attains school-going age. That's a delay of around 5 years, which is precious time lost not only for your investments to start accumulating but for interest to compound as well.
For instance, say you want to invest KES 1 million for your child’s future and give him when he turns 18. Here’s how much your child will get with a rate of 10%.
Age of the child when you begin investing
Number of years left for your child to turn 18 years of age
Expected rate of return
What your child will end up with
From this, you see that your chid will end up with less money but thinking of starting at 10 years old is not something that will bother many parents since they think the child is still young. However, comparing starting at 10 and starting at birth is a difference of a staggering KES 1 million.
1. Not accounting for inflation
Inflation refers to the perpetual rise in the cost of living over time. In other words, the purchasing power of money reduces with time. This is a very significant factor for your child’s investments since they are very young and require a lot of time until they can access these investments.
Firstly, this means doom not only for household income but child-specific expenses such as education. Future costs of education could be much higher than the present costs. For instance, the total costs of attending the MBA programs in the top 25 business schools are on the rise. So, as a parent, you need to account for this in investing in your child's future. Otherwise, you may not have enough to enroll your child in the best education institution.
For those of you with sons, how will you raise dowry?
2. Overestimating your investment returns
While inflation makes the cost of goods and services rise with time, you also need to account for possible reductions in your investment returns. Take the case of good old fixed deposits, for instance. Where many banks used to offer interest rates as high as 12% per annum earlier, the average FD rate has now fallen to about 7%. The best performing ones may reach 8.3%.
It's important to account for this kind of a dip in the returns when you plan for your child's future.
3. Failing to align your investments with your goals
Investing without any specific goal can be catastrophic for your future plans. As a parent, it always helps to identify the future goals in your child's life, estimate the amount needed for those goals, and work backward to figure out how much you should invest today.
Another common mistake that many people make is choosing short-term investments for long-term goals, and vice versa. The smart thing to do would be to select investments with short-term horizons for the near-term goals in your child's life, taking them on a vacation next year. For the major goals due later in life, like getting into university or planning their wedding, you can choose long-term investments.
4. Overlooking the importance of life insurance
Investments help you plan for the known, while insurance prepares you for the unknown. Unfortunately, many parents shy away from purchasing an insurance plan maybe because they have other investments in place.
What people don’t want to consider is the possibility of their own death before the child is old enough to care for themselves; they often overlook that in case of their unexpected demise, a life insurance plan offers unparalleled financial protection for their child, ensuring that their life goals are on track. So, ensure that you include life insurance in your portfolio.
5. Relying solely on 'safe' investments
If you're a conservative investor, you will naturally lean towards fixed income products and other safe investments that offer guaranteed returns. But investing solely in debt and fixed income options can be a costly mistake, because these products rarely offer inflation-beating returns. Fixed deposit accounts may offer about 7.5% interest while inflation is over 8%. This does not help your portfolio at all.
Spreading out your investment funds across different asset classes can help you avoid an erosion of your portfolio by inflation. When your child is still young, you have time on your side. So, you can afford to invest in high-risk, inflation-beating assets like equity and real estate. You can migrate to safer assets later, when your child grows up a little more.
6. Not reviewing your investment plan
Even if you get all of the above areas right, overlooking the importance of reviewing your plan can cost you dearly. You need to revisit your investment plan every year or so and ensure that your investments are performing as planned.
If the basis for the initial asset allocation has changed, review it and rebalance your portfolio as needed. This way, you can make sure that you are on track to meet your child's future milestones without any delays or downgrades.
Creating a financial plan for your child's future may be challenging initially. However, with a few small areas covered, like goal-setting, asset allocation and periodic portfolio reviews, you can sail through the years and watch your investments grow just as you had planned. And then, when the time comes to fulfil your child's big dreams, everything will work out just right!