Wall Street Steward

January25th

When my youngest child was born, instead of celebrating wildly that another blessing had entered my life, I thought about a #mathematical# problem. 

HOW MUCH DO I HAVE TO SAVE MONTHLY TO PAY FOR HER EDUCATION?

This is a question that I should have already answered, being that I am a financial guy, but since I am going to answer it for myself, I figured that I would let you all in on the fun as well!

In my world, we are saving for a state-supported school.  Trust me, the numbers will be high enough to make you nauseous…the last thing we need to save for is a 4 year degree from Harvard, agreed?  Ok, in-state tuition and room and board for a public university.  Got it.

According to this article, the average annual cost of the top 10 “best value” public schools in the country is $18,499.  So, 4 years would cost just under $74,000 ($73,996) in TODAY’S DOLLARS

What shall we use as the ++inflation++ rate?  Here is the rub….nobody knows for sure what the inflation rate for education costs will be going forward.  If we use history as an indication, the costs increased 7.9% for the 2010-2011 school year, but have averaged *only* 5.6% per year over the last decade.  I am going to split the difference and use a hypothetical rate of 6%. 

Newborn child…check
18 year time frame…check
Hypothetical inflation rate of 6% per year…check

My little girl is not going to school today, but in 18 years.  That means we must determine what the cost will be in 18 years.  We simply start with the $18,499 that it would cost in today’s dollars and compound it with a 6% inflation rate.  That means that the first year my youngest daughter enters school, it would cost $52,802 if my hypothetical rate came to fruition!  Worse yet, since we have to inflate the cost each year, her 4 years would cost:

Year 1:  $52,802  (Freshman year 2029)
Year 2:  $55,970  (Sophomore year 2030)
Year 3:  $59,329  (Junior year 2031)
Year 4:  $62,889  (Senior year 2032)

Grand Total:  $230,990!!  Let’s throw a 10 spot in there just to round the number to $231k.

So, in theory I need to save enough each month so that she will have $231,000 in an account when she enters school in 18 years.  One last input:  what growth rate will we use?

Depending on your optimism, I have calculated several scenarios using different rates of return.

Annual Growth            Total Needed              Monthly Savings          Pre-tax earnings
6% per year                    $231,000                         $596.36                           $851.94
8% per year                 $231,000                        $481.16                           $687.38
10% per year                  $231,000                         $384.64                           $549.48
12% per year                  $231,000                         $304.81                           $435.44

For the sake of this article, I’m choosing a hypothetical rate of return of 8%.  The reason for this is that the stock market has averaged 10% per year over a long period of time (1935-2009*), but we need to account for the associated fees that any investment option will have.  Because of that, I will use the 8% hypothetical return in my case.

Keeping in mind that the monthly amount to be saved has to be AFTER-TAX money, I added a column for what must be earned each month on a pre-tax basis (assuming total taxes, 401(k), benefits, etc. cost of 30%).

So, “Matty Boy” needs to earn $8,250 per year to JUST fund my child’s educational costs.  Not to pay the mortgage or to keep food on the table….but JUST to setup my daughter for school in 18 years. 

Now, just to make you feel good about your situation, I write the following…

I have 3 kids.  *getting light headed*
They are 5, 3, and 1 so I don’t have 18 years left to save.  *woozy now*  
Inflation could be higher than 6%.  *here comes the VOMIT*
My investments could earn less than 8% per year.  *wiping the puke off my lapel*

According to one of the bankers I work with, one could purchase an automobile for $25,800 and finance it for 5 years at 4.50% interest and end up with a car payment of $481.

So, saving $481 per month for education is equivalent to buying a new automobile…except that the car will be paid off in 5 years but the education will not be paid off for 18 years!

*I just PASSED OUT*

PROBLEM
This is a problem that many people have already noticed, as have I.  VERY few people earn enough money to be able to fully fund their children’s education.  Will the government step in and regulate the inflation rate that Universities can impose?  Who knows.  Will the scholarship “purse strings” be loosened to allow more people to access those dollars?  Maybe. 

The only answer I know of is to start as early as you can, and save as much as you possibly can because this is a nut that even “well off” people will have a hard time cracking.

Creative Commons License photo credit: Upsilon Andromedae

Disclaimer: All examples provided in this article are hypothetical and are not representative of any specific situation.  Your results will vary.  The hypothetical rates of returns may not reflect all the deductions of fees and charges inherent to investing.
*Source – Stock market:  Standard & Poor’s 500 Composite Index, with a reinvestment of dividends

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