How Much to Save for College?

How Much to Save for College?

Our approach is a) college savings is a monthly budget item, b) our kids will be aware of two cost savings routes that make a degree 25% cheaper.

My wife and I agree that we would rather save for college in advance vs paying out of pocket when our kids get there. Day care is back breaking enough as it is ($1500 / month). By the time they get to college I’d like to have it pretty much paid for in advance.

That said, we want our kids to pay for part of their college so they have skin in the game and they get a better sense of value and accomplishment out of the experience. At the same time we want them to feel loved and supported. So we have to strike a balance somehow. Splitting the cost sounds about right. However, given the unknowns we’d like to have a little padding in case the market tanks or our child gets into an awesome school.

TLDR: My wife and I ran the numbers and came up with a range we can live with which involves saving $150/month per child (we have two kids). That will be $32,400 in contributions per child over 18 years. If we assume a 7% nominal rate of return by investing in stocks and bonds we’ll have about $70k (on average). It isn’t perfect but it feels like enough for us.
 

There are two big unknowns when calculating how much to save for college: 

  1. What return we will get in the market on the money we saved? We assumed a 7% nominal return. That may seem high but the average on a 50% stock / 50% bond portfolio has been 7.7% since 1928.
  2. What will the actual cost of college be 18 years from now? We assumed the price will double, which is about a 4% compound rate of return and double the Fed's inflation target.
     

Rough cost figures for college tuition and two pathways to make college cheaper:

Getting a bachelor’s degree doesn’t necessarily mean going directly from high school to a four year school and staying there for 4+ years. That is the conventional wisdom the big schools want you to believe, because of the “experience” they are selling. If your goal is to get that slip of paper (which is the primary result of college, completing a set of requirements), there are better ways to get it done.

Transferring to a four year school from a community college or using AP credits from high school can save about 25% off the cost of tuition. These options also make nice tests to see if a person is really “college material”. Why not weed them out at $50 per credit vs $200 per credit?

Route

Tuition Cost (2019 dollars)

Community College 2 Year Degree

$11,000

Community College then Transfer to University

$11,000 + $23,000 = $34,000

3 Years at University (using AP credits from high school enter as a sophomore)

$34,500

4 Years at University

$46,000

Our local community college, which is just a 15 minute bus ride away is currently $1,850 for a 16 credit term, counting books. A two year degree would be 6 terms, or about $11k in today's dollars. Community college is a good starting point for people who are not sure if they are “college material”. A two year degree can get you a variety of entry level jobs in good paying technical areas that offer ample career growth. Or a 2 year degree can be transferred to a four year university which is an excellent tuition saving strategy. Personally I found my community college teachers to be more engaged and polished than many of the aloof college professors and teaching assistants “aka training monkeys” I had at my four year school. I did not get a 2 year community college degree but I ended up transferring about 100 credits to the big school.

Our state’s most popular public university is currently $3,800 for a 16 credit term, counting books. Going straight from high school to the public university would require 12 terms, which totals to about $46k in today's dollars.

Combining community college and a four year university provides a bit of savings. With a 2 year transfer from a community college, you’d only need 6 terms at the “big school” to graduate. The total is about $23k (university) + $11k (community college) = $34k in today's dollars.
 

What is not in the numbers above:

These figures are only for tuition and don’t include housing, food, transportation, health care, etc… We’d probably be paying for housing and healthcare anyway so we’ve excluded those costs from the analysis.

These figures are in today’s dollars, and do not reflect tuition increases and inflation! 


 

What about big name schools or private colleges?

My wife and I both agree we are not going to bother planning for out of state tuition or worse yet international tuition. That is likely to be 50% - 200% higher. If my child wants to go to an out of state college or get their degree in another country that is their call. But I will repeatedly warn them about the extra cost of tuition and the massive debt and reduction in ROI it involves.

We will encourage our children to pursue their dreams and shoot for the stars in terms of getting into a big name school, but we are not going to budget for the ivy league. If they get a scholarship* that is great, in which case this analysis is moot. If my child gets into an awesome program in a cutting edge area which happens to blows the roof off our cost estimates, we’ll do our best to make it work. Maybe we’ll be forced to chip in more later (but we’d gladly do that). That is contingent on us having an income at that time. I doubt we’d take a second mortgage the house to make it happen.

Part of our thinking is my wife and I both went to our local state college with essentially zero financial help from our parents. She took the AP credit route and I took the community college route. We both got out with negligible debt. We worked to support ourselves while in school, which is something we had in common and admired about each other when we met. In some respects I think having a degree from the local university is a better status symbol vs getting an expensive degree from some big name school. Many people in our area did the same as us which makes us part of that club. It is practical and economical, which says nice things about us yet doesn’t put people off.

* A caveat on scholarships: they must be for 4 years. Many private schools lure students with shady one year scholarships. They trick people into paying for the remaining 3 years using student loans.

 

So we are looking at anywhere from $34k to $46k to pay for college (in today’s dollars):

Recall that we want our children to "earn" their degrees by paying for part of it themselves. Not wanting to foot the entire bill ourselves, we could set a goal for $35k and be okay if the market tanked and could only give $30k, or have a little excess for a nice vacation if the market does well.

Accounting for inflation and the systemic rise in college tuition, a safe target for us is ~$50-70k in 2037 dollars. That works out to a 3.9% compounded rate of return, but it is just a guess. It may be optimistic the way colleges are jacking up tuition year after year, but it is still above inflation which is projected to be around 2%.
 

In theory there are a few ways to pay for college:

  1. Make monthly contributions to a college fund from the time the child is born to the time they enroll. This is essentially dollar cost averaging into the market. A popular way to do this is through a 529 plan which grows tax free. Some states offer tax breaks on contributions.
  2. When the child is born make a lump sum contribution, hoping by the time they are 18 it will have grown enough to pay for their college. Generally lump sum contributions yield higher returns than dollar cost averaging but it comes with some risk.
  3. Do a combination of #1 and #2, so a smaller lump sum enjoys the effects of compounding but the monthly contributions smooth things out.
  4. Save nothing until they actually enroll, then pay out of pocket. This sounds extremely stressful. Who knows if we will still be employed or even alive by then. My wife and I are not willing to leave it to chance.

Option 2 is really only possible for children who have a wealthy parent or grandparent. I like the simplicity of this option but definitely can’t afford it. That leaves us with some form of monthly savings to fit into our budget. It begs the question, how much should we save each month?

Using our Saving for Retirement Calculator, and a 50% stocks 50% bonds allocation over 18 years of saving we get the following numbers:

I picked the 50/50 allocation purely for example purposes, do your own risk analysis and figure out what allocation makes sense for you. The calculator will let you adjust it.

 

Average Ending Balance After 18 Years

Range (Low - High)

Total Contributions

Link

Lump Sum $10k

$42k

$16k - $115k

$10k

Edit

Lump Sum $20k

$85k

$33k - $231k

$20k

Edit

Lump Sum $30k

$127k

$50k - $346k

$30k

Edit

$5k to start, $50/month

$44k

$21k - $99k

$5k + $11k

Edit

$5k to start, $100/month

$67k

$33k - $142k

$5k + $22k

Edit

$50 / month

$23k

$12k - $43k

$11k

Edit

$100 / month

$46k

$24k - $87k

$22k

Edit

$150 / month

$69k

$36k - $131k

$32k

Edit

$200 / month

$92k

$49k - $175k

$43k

Edit

Follow the links above to tweak the numbers yourself and play with the allocation.

Note these numbers are not inflation adjusted! We had estimated $50-70k in 2037 dollars will be needed (per child).

If we save $150 a month, we are looking good “on average”, but if the economy goes south we will fall short. Then again if the market does well, we’d have almost double our estimate which means mommy and daddy get a nice vacation and maybe a new car out of it! 

It is interesting to me that the $10k lump sum and the $100 / month plan have similar resulting balances, but the lump sum is $10k and the $100 / month plan is $22k in total contributions. This is because with the lump sum plan, the full effect of 18 years of compounding is in action. At the same time the lump sum plan has a much lower worst case scenario value ($16k vs $24k) which illustrates how dollar cost averaging reduces risk.

 

In Summary:

To help our kids through college we are looking at saving $150 - $175 per month invested in a 50/50 (stock/bond) fund over 18 years. This should give us anywhere from half to all of a four year degree paid for. Even in a worst case scenario we’d still have about half their college covered which is way more than we got from our parents.

We plan to encourage our kids to use strategies to reduce the total cost of a four year degree such as AP classes and transferring from a community college. 

Paying for college in advance at birth requires less money out of pocket, but the range of the final balance is much wider. Paying for college using monthly payments costs more but the ending balance range is much smaller. Dollar cost averaging into the overall position means paying to reduce downside, but also limits upside because compounding is reduced.

Our Saving for Retirement Calculator can be used to model college savings scenarios. It uses back testing, which means it uses historical data. Past performance does not guarantee future results.

The post How Much to Save for College? is part of a series on personal finances and financial literacy published at Wealth Meta. This entry was posted in Family and Finances, Budgeting
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