Good news, right? So what’s the trick?
Actually, there is no trick. Follow along for about two minutes.
For the sake of illustration, let’s say a child is born this year and you want to plan financially for her college education. We’ll make the assumption that you expect to pay for a traditional four year degree. Further, you have a personal goal to pay for college without the need to take on any debt at the time the tuition bills are due.
How long do you have to grow your investments to meet this obligation?
Related: See Financial Calculation Tutorial – Paying for College
In the US, most children are ready to start college at eighteen or there about. Therefore, you probably expect that you have 18 years to save and invest for their education if you start the year the child is born. But in reality, you have about three and a half years longer or 21.5 years.
“How’s that?” you ask.
Just think about it for a moment. The entire cost of college is not due the day the students starts their studies. While payment plans vary, one typical way to pay for college is to pay the cost of each semester at the beginning of the semester. That means for a typical four year degree the final payment isn’t due until about three and a half years after the student starts their freshman year.
The point of financial planning is to design an investment plan whereby the investments pay for the goal – not your current personal income. The goal, in this case, is to pay for a four year college degree.
Since you won’t need to have the final tuition payment available until approximately three and a half years later, when they are starting the final semester of their senior year, you can continue saving and investing until the student is about 21.5 years old.
“So what?” you ask.
By having a few more years to invest, each periodic amount you invest can be somewhat less than if you (aggressively) set the goal to have four years of tuition saved by the time they start school. The longer you have to reach a financial goal, the less you have to invest each period to make that goal. Saving for a college education can be difficult. Being overly aggressive and planning to have the entire amount available when the child turns 18 overstates the periodic investment amount required.
Following this plan, the tuition payments will be taken out of the investments even as new
amounts are added to the investment. A tricky financial calculation, no doubt, but our Ultimate Financial Calculator is able to do it
The below two example schedule fragments from the Ultimate Financial
Calculator show the different investment amounts needed when investing for 18 years versus investing
for 21.5 years. Assuming each semester is going to cost $15,000, the first 18 year investment plan
requires that $311 be invested each month and the 21.5 year investment plan requires that $280 be
invested each month.
Related: To customize the calculation
to meet your needs see Financial Calculation Tutorial –
Paying for College
There is a downside to making lower periodic investments. Take a close look at the above schedules. Notice over the course of 18 years, $67,174 dollars will have been invested to pay for a $120,000 education (8 x 15,000 per semester). But when the term is 21.5 years, the investments total $72,346. This is logical. The more one saves or invests the greater the opportunity for growth due to the benefits of compounding. Thus less has to be invested to reach the same goal.
Study the schedules created by the TVM financial calculator to see what happens.
What do you think of these strategies? Feel free to offer your thoughts or feel free to ask a question below.