Simple but Important Calculation: How Much Should You Have Saved for College Today?

While not all parents agree on which type of college their kids should attend, how much of the cost they should front, or whether a college degree is even worth the immense upfront expenditure at all, what is virtually unanimous is that given recent trends in tuition it’s a terribly expensive undertaking that will likely worsen over time given other developments in the economy, endowment investment losses and other economic factors.

According to the inflation trends at the College Board, the average annual increase over 10 years was 6.5% for a 4 year public college while increasing 5.2% at private colleges.  Meanwhile, core inflation, wages, or whatever other measure of purchasing power you consider to be relevant was much lower – in the 1.5-3% range.  Therefore, the cost of college in real dollars has been increasing substantially each year at virtually double that rate, and if you have a child born this year, it’s entirely plausible this painful trend will continue unabated for the next 18 years.  Over time, the power of compounding is sure to make the college experience daunting to those who didn’t adequately prepare in advance.

There are myriad assumptions and calculations out there for how much you’ll need to save for college, but given the wild swings in outcomes of various investment classes, assumptions surrounding which college costs to assume and hundreds of other variables, what I’d offer is a very basic high level set of assumptions that will allow you to immediately get an idea of how much money you need either for a new child or how much you should have saved (and will need to make up) for a child approaching college age:

Assumptions:

• Child attends college at 18
• Child attends 4 year public or private school – for estimate use 2010 average of $15,213 for public and $35,636 for private
• Money is invested in a typical tax-advantaged college plan like a 529 or ESA
• Returns on investments are roughly equivalent to college cost inflation – This is a key assumption and I’ll explain below why I used it

Now, there are a few assumptions that you are your children need to discuss during the college selection process, and these may change along the way as well.  First off, is college even appropriate for your child?  For many, the answer is yes.  However, let’s say your child just didn’t excel in school, didn’t enjoy it and barely got by…but perhaps they love a particular trade that may provide a decent income in adult life?  College isn’t for everyone and there are perfectly successful and content workers and entrepreneurs that don’t have college degrees.  Once that question is answered in the affirmative though, the next consideration is what burden of the total costs are to be borne by the child versus the parent.  If you tell your kid, “You can go to whichever college you like, but we’re only able to provide for $15,000 per year (in 2010 dollars) and you’re on the hook for the rest”, chances are they’ll opt for a state school.  If you want your child to be able to attend any school they want and you’re doubtful they’ll be the recipient of a scholarship or any sort of aid given your income (this is the most conservative assumption), then you’d better plan for the bull $36K/year in today’s dollars.

For the assumption on investment returns, there are a few factors at work here.  First off, while the long-term return on stocks is generally touted at 8-9% annually, the reality is that this is not guaranteed, and also, you’ll likely want to adjust your asset allocation to shift into more conservative assets as your child approaches college so as to not see your plan drop in value by 50% in a blink of an eye like we saw across 2008-2009.  For instance, perhaps at age 1, your child’s plan is invested fully in stocks, but by 14, you’re down to 65% stock and 35% bonds/money market.  Therefore, even with a rosy 8% assumption, given this asset switch along the way, your real returns through the life of the term are probably closer to the annual college inflation costs.

Now, you might say these assumptions are way to simplified, broad and back-of-the-napkin.  Well, maybe they are.  And maybe you’ll want to spend the next 3 months tracking down a financial adviser who’s going to charge you a lot of money (either upfront or from fees by putting you into investments in which they derive fees) to tell you something different, but at least here, you’ve got a start.  You have an order of magnitude wake-up call on just what it’s going to take to put your kid(s) through college.  Start today with this goal in mind as opposed to trying to find someone who’s going to tell you something you’d rather hear – that it will be cheaper, how to get scholarships, or whatever sounds better than these large numbers.

What Happens if You Saved Too Much?

While this is hardly a common problem since even these costs are likely underestimated and adjustments could be made along the way, the beauty of the 529 College Savings Plans is that there are several alternatives at your disposal if you encounter that situation ranging from using the money for another child to various options for withdrawal (see 529 Plan Basics for more details on this and which plan we’re using).

How Are We Doing?

In looking at it this way, we’re behind the 8-ball a bit.  While we do have several thousand dollars save for each kid, we have three kids and we want the ultimate flexibility (most conservative assumption) of a top private college with no assistance, we’re talking about saving $428,000 in today’s dollars.  That’s a staggering amount!  It’s another mortgage (way more than our current one by the way) but to be paid in half the time!  Our actual plan involves my wife returning to the workforce once our youngest is out of the house and into school and having my wife’s salary to virtually do nothing but shovel money into college accounts.  But that’s taking on a bit of risk in assuming they’re hiring teachers again in a couple years and no other lifechanging events occur.  So, admittedly, it’s daunting for us as well, but we’ve got a plan, we’ve got a backup plan, we’ve already started investing for each child, and I know what we’re up against.

How Do You Stack Up?

Tagged as: 529, College Savings