3 Steps to Find the Magic Number

Worried about how you’re going to pay for your children’s college education? You’re not alone. According to a recent study from Discover Student Loans, parents overwhelmingly see the value of their kids going to college. However, 85 percent of all surveyed parents said that they’re concerned that student loan debt could limit their kids’ ability to purchase homes, cars, or other big ticket items in the future.

It’s a valid concern. Americans have more than $1.2 trillion in student loan debt. That number is only going to get bigger as college tuition continues to rise.

Your kids don’t have to be burdened by student loan debt, though. A disciplined savings plan can help you pay for a significant portion or even all of you child’s college tuition. The keys are to start early, save regularly, and invest properly. To get started, follow the simple three-step process below:

1) Find out the current costs for your target schools.

There are some great resources online for finding current college tuition. One of the best is www.collegedata.com, which also has information about school demographics and admission requirements. You can search the site for nearly any school to get tuition information.

Here’s an example for the University of Southern California. As you can see, current tuition, including room and board, for USC is nearly $65,000.

2) Calculate the future cost of tuition.

It would be great if college tuition stayed the same from year-to-year, but, unfortunately, that just isn’t the case. In fact, college tuition has gone up twice as fast as overall inflation over the past 10 years. To estimate your child’s tuition, you can use this calculator to determine how much tuition will increase in the future.

First enter in the current cost of your desired college’s tuition. Then enter in an inflation rate of 5%. Next, figure out how long you have until your child goes to school. If your child is five years old today, you likely have 14 years until they’re ready for school. You can see that the future cost of your child’s freshman year at USC will be $128,696. The cost for all four years is going to be $554,694. That’s your target.

3) Determine your savings amount.

You now have a goal to shoot for. The next step is to convert that goal into a monthly savings target. The biggest factor in this is what kind of return you’ll get on your savings.

Example: assume you’re going to put the money into an investment that pays 4% average returns over the life of your plan. In our example, you would need to put away $2,468 per month for 14 years, to make sure that you had your four years of tuition in the bank when your child starts her freshman year. 

But, what if you instead invested the money in a diversified portfolio that averaged a ten percent annual return? In that case, you need to save about $1,525 per month.

This idea is similar to your mortgage. When you apply for a mortgage, the interest rate heavily influences your payment. The higher the interest rate, the higher the payment because you have to pay more money to the bank every month. With college savings, the inverse is true. The higher the rate of return, the less you need to put away every month. The best part is that you’re paying yourself instead of paying the bank.

The most important thing is to start saving as early as possible. Even if you can’t reach your full savings target, at least try to put something away. The cost of waiting can be substantial.

In our example, consider what would happen if you waited until your child was in 4th grade to start saving. Even if you did get a ten percent investment return, waiting just five years would bump your required savings up to $3,187 per month vs. the $1,525 if you started four years earlier. On the other hand, what if you started as soon as your child was born instead of waiting until age five or age eight? Again, assuming a ten percent return, having those extra years would push your required savings down to $924 per month.

So follow these three steps – and most importantly, start early and invest where you have the expectation for higher long term returns. If you do that, you’ll put yourself in great position to be able to contribute towards your child’s education costs.