Use MF child plans as wealth creators

Whenever there's a news of arrival of a newborn in the family, along with the excitement, the family elders would want to create an estate or a gift for the just born. The traditional ways of looking at providing this need is through physical or financial assets.

The foremost in the physical assets is by Real Estate (a plot or a flat) and Gold (mostly through ornaments). The most preferred route in financial assets however has remained the bank fixed deposit.

With the central bank reducing the interest rates, the bank FD option is turning unattractive and the taxation on interest earned also douses further.

Of course, the other in the list of favorites has been life insurance which would mature into a decent sum at the end of the tenure.

Another, not so productive option though is the piggy bank accounts. Piggy banks are more of an option of savings than investments for children for inculcating savings habit all over the world.

Yet, post-demonetisation and with the advancement of digital transactions, parents are confused if they could continue to opt for this style of savings. What's mostly ignored or remains unaware is the mutual fund (MF) option which could be explored for better returns in the long run.

Child plans are nothing but hybrid MFs that have the fund exposures to equity and debt. Most plans are aggressive hybrid funds where the equity exposure is at a majority i.e. a minimum of 65 per cent of the portfolio while the rest is invested in debt, cash and/or cash equivalents.

This makes them to be considered as any equity in terms of taxation despite the reduced attractiveness due to the imposition of long-term capital gains tax over the return earned beyond a year of investment.

The current volatility in the equity markets augurs well with these funds as the exposure is limited unlike the pure equity funds. Asides, the notion of accruing a corpus for an emotional cause of child's future aspired through a secured investment.

Though this is not a secure investment or with risk relatively higher than that of the earlier mentioned traditional avenues, the long-term risk-reward favors an exposure into these investments.

If we look into the past performance of these kind of funds, the returns have been attractive, and the dual play of debt & equity has been a smart combination. The near non-correlation of these asset classes helps to tide away during their performance cycles.

So, to benefit from long term investing and better post-tax returns, child plans of MFs are a good choice for investing on minors. MF investments could be started on any named child with valid proof of date of birth.

The folios unlike the normal MF investments can't have joint holders of the units. A guardian is mandatory and could be either parent or legal appointed with a proof of establishing the relationship. Ideally, the guardian is one of the parents while the investment could be done by any.

Considering the long-term nature of these investments, these funds come with exit loads. These loads or penalties peter down over periods of time from the date of investment with the first year being the highest and mostly ceases beyond three years from the investment.

The hybrid nature of these plans allows one to invest in lumpsum with a medium to long-term while investment could also be done through a Systematic Investment Plan (SIP).

Seamless in the opening and operation of these investments, nevertheless, any redemption proceeds would go to the bank account of the minor where the guardian should be the same as in the folio.

This sometimes turns a hurdle, especially when the initial lumpsum investment is made by a grandparent or others while the guardian is one of the parents. In these cases, particularly when the investment is made right immediate to the birth of the newborn, there wouldn't be a bank account in the name of the kid and the grandparent.

This could turn into trouble when the parent plans to do changes to the original investment. Moreover, any dividends or capital gains would be accrued to the income of the guardian and accordingly taxed.

When minor turns to major all the existing instructions like SIP would be suspended and the major KYC needs to be updated. Despite the sentimental value attached, its ideal for the parent/guardian to invest in their own name with the child as a nominee to avoid operational complexities.

(The author is a financial journalist and technical analyst. He can be reached at tbchary@gmail.com)