The cost of a US public university education for a child born today will be about $80,000. A parent could invest about $2,000 the year their child is born, and increase that contribution by 5% each year to make sure that child can go to university. They could do this by buying a broad market fund or ETF depending on what suits their situation, and contributing money every year.
The Cost of a US University Education is $40,000 and Rapidly Increasing
The College Board in the US has recently announced its estimate of the cost of a four year college education at a public university – a whopping $40,000. They also show that the cost of that education rose by about four percent per year over the last 30 years. If we use this four percent rate of increase, that means that in 18 years, that same college education would cost about $80,000.
Average Annual Long Term Returns in the Stock Market have been 8-12%
Returns in the US stock market over the last 30 years have averaged 11%. Depending on the time period, over the last 100 years, the US stock market return has ranged from 8-12%. When estimating future US stock market returns, I use the lower end of that range, just to be conservative.
Your Actual Return Could be Much Worse…or Better
The problem is that although eight percent is a long term average, the actual yearly changes can be very different. If a person starts investing in years when the stock market is particularly high, then their long term return would be much lower. In extreme cases, the stock market could end up producing half of the long term return, or if you’re lucky, double, depending on how high or low the stock market is when you start. Don’t let anyone convince you that this is something that you can know ahead of time.
To Build an Extra Cushion, Aim for $100,000 in 18 Years
To deal with this unknown, I add an extra $20,000 to the $80,000 required, so that the target amount we are aiming for is slightly higher than the original $80,000. This way, if the stock market were to be a disaster over that 18 year period, your child would still end up with close to the $80,000 needed.
Parents Saving for a Child’s University in the US can Reduce Taxes to Zero…but Few Do
In the US, parents can eliminate taxes by using a 529 Plan college investment plan. The money needs to be invested in an approved investment fund offered by an approved investment company. This could be mixed between stocks and bonds. A recent Sallie Mae survey shows that half of families with children under 18 who intend to go to university are saving for college. About 30% of those that are saving say they are using 529 Plans. Based upon this survey, for the purposes of this analysis, I will assume that the parent does not take advantage of this option. This would mean that the parent would pay taxes, which I assume would be 20%, paid on the gains at the end of the period.
It’s Best to Increase Payments Toward Education Each Year
Another assumption that needs to be made is the average annual increase in contribution that a parent can afford. I assume that each year the parent can contribute five percent more than the prior year to their child’s education.
When your Child is Born, Start Investing $2,000 Each Year, and Increase that by 5% Each Year
Based upon all these assumptions, a parent who saved for each of the 18 years until their child’s university days would need to set aside $1,950 in the first year, and then increase that contribution by five percent each year.
Start Today! Follow this Simple Method of Investing for your Child’s University Education
Investing can be complicated, and that complexity usually causes people to take no action – this is a big mistake! Though things can get complicated with a 529 Plan or some mix of stocks and bonds, it’s important to start NOW. Take that $2,000 and set it aside today. The easiest thing to do is to open up a bank account and put that $2,000 into it (or even more simple, divide $2,000 by 12 and contribute $167 per month). Then, you can say you have started…and your anxiety will be gone. In the beginning, the habit of contributing is more important than where you put the money.
Once you are Ready to Start Investing, Consider Funds or ETFs
As always, you must figure out what is right for your situation, and companies like Vanguard, Charles Schwab, and Fidelity (I have no affiliation to any of these) can usually provide some great advice as you set up accounts to invest in their funds or exchange traded funds (ETFs).
A Few Investment Options that may Suit your Needs
Below, I highlight five different ways that you could get broad US stock market exposure at a very low price. Two passive index funds which give an investor broad US stock market coverage are: Vanguard Total Stock Market Index Fund (with a 0.17% fee) and Schwab Total Stock Market Index (with a 0.09% fee). In addition, these three ETFs could give a similar exposure: Vanguard Total Stock Market (VTI), fee of 0.05%, Schwab US Broad Market (SCHB), fee of 0.04%, and iShares Core S&P Total US Stock Market (ITOT), fee of 0.07%. Whether a fund or ETF is right for you depends on your situation. But remember, no matter which of these options you choose, getting started is probably more valuable than what you contribute.
The price of a university education has definitely soared, but don’t let that hold you back from investing in your newborn’s education. Just $2,000 starting this year can get you started on the right track.
How do you prepare for your kids’ college education? Do you go with passive or active investing? I would love to hear your thoughts! Any comments or question you might have, I would like to know. Is anything unclear? Please let me know in a comment below.
Price of a college education
US economy overall Inflation rate
US Inflation Calculator
Long term return in the US stock market
Type and amount of savings for college
Funds and ETFs
DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.
Originally published on August 5, 2015 at: www.equities.com.