Corporate Fixed deposits: A practical way to fund your kid’s education

Funding one's kid's education has become a cumbersome task for many households in India. Rising cost of education and shrinking savings make it tough for parents to accumulate a wealth pool which can fund education. If a kid's higher education is in a far away country then most financial planners recommend investments in equity funds.?

In the long-term, exposure to equities can be rewarding However, when a financial goal is nearer the money needs to be moved from risky assets such as stocks and equity mutual funds to bonds, fixed deposits and debt funds. Corporate fixed deposits can be of great help at this juncture. Here is how they work to the benefit of parents.

Safety

Child’s education is a non-negotiable expense. No parent wants to postpone sending his or her child to college nor want to settle for a lower rung institution for inadequate funds. This calls for parking the funds in a less-risky avenue. Corporate fixed deposits with AA and AAA ratings fit the bill. These ratings offer comfort. Large non-banking finance companies have withstood the test of time. They had repaid their obligations even in the most testing times, such as the Covid-19 pandemic induced lockdowns.

Returns

Though the fixed deposits with AA and AAA ratings are safe, they do not compromise on interest rates. Compared to the interest offered on bank fixed deposits, they offer better rates. For example, today a nationalised bank offers a 6.75% rate of interest on a three-years fixed deposit. However, NBFCs offer 8.25% to 8.75% rate of interest on similar tenures. Interest rates may vary depending on the payout frequency of interest.? Since the Reserve Bank of India expects inflation to be 4.5% for FY25, current interest rates are very attractive.

Liquidity

Given the high interest rates and adequate safety many may find it attractive to consider corporate fixed deposits. However, the interim liquidity must be kept in mind. Corporate fixed deposits reduce the interest payable if the depositor asks for pre-mature withdrawal. Investors should ideally match tenure of the fixed deposit with their investment time-frame.

Laddering

To strike a balance between the returns and liquidity; and ensure that corporate fixed deposits fund child’s education, an investor can opt to ladder her money. For example, a three-year course beginning 13 months from now, may warrant payments at the end of each semester. An investor in such case, opt for fixed deposits maturing every six months, the first FD maturing after 12 months. Each fixed deposit maturing just before the due date of fees should work in favour of investors. Long-term term fixed deposits tend to earn more than their short-term counterparts. This should ensure that an investor need not have to face the brunt of premature withdrawal rules.

If an investor does not have a clearly defined goal, then also laddering may work in her favour. First, it helps her with cash flows from maturities across time periods – over the next one to five years. Each fixed deposit matures at a different moment in future. The interest rate situation may differ and an investor gets to redeploy the proceeds at a different rate of interest. If all the money is invested in the highest possible rate of interest offering tenure and the fixed deposit matures at a time when the interest rates are at bottom, an investor is left with no choice.

Hence, spreading across time periods and across issuers can be a great strategy while investing in fixed deposits. Today most banks are offering the highest rate of interest on 15 months tenure. Investors, keen to invest in 15 months fixed deposits with a lure of high interest rates, are exposed to the reinvestment risk. Interest rates are expected to come down in the next one year.

Making multiple fixed deposits can also help an investor if she is not sure about the usage. For example, instead of making one fixed deposit of Rs 20 lakh, it makes sense to make more than one fixed deposit aggregating Rs 20 lakh, say 2 fixed deposits of Rs 10 lakh each. If a need arises one can be broken before the due date and another runs the full tenure at contracted rate of interest.

While funding a financial goal including child’s education, investors must keep in mind the risk-reward trade-off. When stock markets are doing good, many investors want to ignore fixed deposits. But, if an investor is keen to invest for short-term (less than five years) then the corporate fixed deposits are very attractive.?

So, ignore them at your risk!

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Disclaimer: This report is prepared in his personal capacity and neither the Author nor Money Honey Financial Services Pvt Ltd assumes any responsibility or liability for any error or omission in the content of the article. Investments in mutual funds and other risky assets are subject to market risks. Please seek advice from an investment professional before investing.

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