According to data published by The College Board, the average yearly cost of attending college (tuition + fees + room & board) in 2015–2016 averaged $19,548 at in-state public schools, $34,031 at out-of-state public schools, and $43,921 at private institutions. Keep in mind, these figures do not include the separate cost of books and supplies, nor possible scholarships and other financial aid that could help offset expenses.
To make matters worse — thanks to inflation — the amount of goods and services $1 can purchase tends to decline over time. Over the past 50 years in the United States, inflation (measured by the Consumer Price Index or CPI) has averaged +4.1% per year. With 4% inflation over 18 years, the purchasing power of $1 would decline by roughly 50%. While we do not know what inflation growth or tuition costs will be in the future, we can reasonably count on both costs to increase over the long-term. So what can parents do to prepare? How can parents put themselves in the best position to combat these financial headwinds going forward? It all starts with a plan.
Step 1: Do Your Homework
To help offset the rising costs of future college expenses, parents (and grandparents) can invest in assets that are expected to grow their savings at a rate of return that outpaces inflation. By doing this, college expenses may ultimately be funded with fewer dollars saved — a win for parents. However, these higher rates of return come with the higher risk of capital loss, therefore an appropriate amount of planning and analysis is warranted, and speaking with a financial planning professional is a logical first step. Additionally, using a tax-deferred savings vehicle, like a 529 plan, allows for tax-free growth of the investments, which also helps level the playing field. Moreover, some states (like Ohio) offer a state tax deduction on contributions to a 529 plan up to an annual limit. For example, Ohio parents can deduct up to $2,000 per beneficiary per year for Ohio 529 contributions made for that amount or more.
As previously stated, inflation has averaged about 4% annually over the past 50 years in the U.S. However, U.S. stocks (as measured by the S&P 500 Index) have returned over 9% annually during the same time period. Therefore, the inflation-adjusted growth rate for stocks has been around 5% per year. As an example, $10,000 invested at this rate for 18 years would result in around $24,000 of spending power when the dollars are needed. Simply said, it makes sense to invest, and investing over a longer time horizon is always better. By investing in stock-like investments, and by starting to save in as far in advance to college as possible, parents can expect to afford more college expenses with less present-day (financial) pain. It is important to recognize, however, that investing in stocks also comes with investment risks. Volatility is a normal part of investing, so tuning out short-term “noise” has historically benefited investors who have maintained a disciplined approach over time.
Step 2: Understand Risk Management & Diversification
Working with a trusted advisor who has a transparent approach based on sound investment principles, competency, and trust can help investors identify an appropriate risk management strategy. Such an approach can limit unpleasant (read: costly) surprises and ultimately contribute to better investment outcomes. Determining how much to save, the appropriate account setup, and how to handle surprises (e.g., scholarships, financial aid, etc.) are all questions that an advisor can help you navigate.
Diversification is also a key part of an overall risk management strategy for education planning. Nobel Prize-winning economist Harry Markowitz once said, “I only have one piece of advice: diversify.” Combined with a long-term approach, diversification helps take the guesswork out of investing. Trying to pick the best performing investment every year is a guessing game, and “chasing” returns is a great way to lose spending power. We believe that by holding a broadly diversified portfolio, investors are better positioned to capture returns wherever those returns occur. As the day your child heads off to college approaches, the investment portfolio should adjust accordingly by reducing the amount of the risk in the portfolio at a measured pace.
For most parents, higher education will likely come with a high (and increasingly higher) price tag, so it makes sense to plan well in advance. There are many unknowns involved in education planning, and there is no “one-size-fits-all” approach to solving the equation. By having a disciplined approach toward saving and investing, however, parents can eliminate some of the uncertainty from the process. A trusted advisor can help parents craft a plan to address their family’s higher education goals.