Select’s editorial team works independently to review financial products and write articles that our readers will find useful. We may receive a commission when you click on product links from our affiliate partners.
Seeing the price of college education today can be a sticker shock for a lot of parents, and rightly so – if you’re willing to spend the money to attend a four-year public college, it’ll cost $ 10. $ 560 on average per year, according to the College Council. The one-year sticker price at a four-year private college will cost you an average of $ 37,650. Although the average cost of college education is lower than sticker price due to college scholarships and grants, paying for higher education is still no easy task.
It can be difficult to know where to start, especially when you have more immediate financial priorities like paying for child care and rent. However, having a plan and investing early is essential to ensure that you or your child doesn’t have to take out student loans and then have to pay off that debt down the line.
Select spoke with Mark Kantrowitz, higher education expert and author of How to Appeal for More College Financial Aid, about how much parents should aim to invest in their child’s education, when they should start and where they should go. should invest their money.
Subscribe to the Select newsletter!
Our best picks delivered to your inbox. Buy recommendations that help you improve your life, delivered weekly. Register here.
Start early and with all you can
The most important part of saving for college is investing as early as possible. Since compound interest is interest earned on both the initial investment and the interest you have accrued, your earnings will be much larger if you start investing at birth.
You can think of it like this: With compound interest, an initial investment of $ 1,000 will earn income of $ 100 after one year if there is an interest rate of 10% compounded annually. Your second year, you will earn an additional $ 110 because you will receive 10% interest on the $ 1,100 you have accumulated.
Kantrowitz recommends the rule of thirds as a rough guide to how much parents should save: one-third of the cost of a four-year college education will come from parents’ income and financial aid, one-third from savings and investments. and one-third of student loans. Once you have decided what percentage of your child’s college education you are willing to fund, you will need to determine how much it will cost you each month.
According to Kantrowitz, about a third of your college savings will come from your investments if you start investing at birth. However, if you start investing when your child is in high school, only a tenth of your college savings will come from your investments. In other words, your college savings will be almost three times as much if you started investing at birth than if you started in high school.
The cost of college increases by about a factor of three every 17 years, so if your child is a baby now, you should aim to invest the current cost of a four-year college education over the next 18 years. .
For example, if you want your child to attend a four-year public college in the state, the current cost of attendance (this includes tuition, fees, and room and board) for one year is $ 26. $ 820, according to the College Board. You’ll need to invest about $ 300 each month from birth to send your child to a four-year-old state public college (assuming a 3% inflation rate), according to Kantrowitz. For a private, non-profit college, you will need to invest $ 600 per month.
If your investments generate a 6% rate of return each year, you will earn roughly enough money to cover 1/3 of your child’s total tuition costs once they turn 18.
Although it may sound like a lot, investing any amount of money each month is a good idea. Implement automatic transfers to your investment account so you don’t have the temptation to spend the money once it’s in your checking account. And if you can’t put a lot of money aside right now, you can increase your monthly contributions over time. Starting to invest early is essential to take advantage of compound interest.
Where should you invest your money?
Yes you are investing for college, you should consider opening a 529 savings plan or state sponsored investment account exclusively used to invest for school. With 529 savings plans, individuals can use the money they withdraw for college and K-12 tuition and other qualifying education expenses without paying tax on investment earnings.
529 savings plans contain a variety of different funds such as mutual funds, bond funds, and ETFs. They are generally recommended for investing for college because of the tax benefits people get from them: you can contribute up to $ 15,000 tax-free (for single tax filers) and your income will grow sheltered. tax.
States offer different 529 savings plans, and you don’t have to be a resident of that state to be eligible for an account. However, some states may offer tax benefits for in-state contributions. For example, in New York City, state residents have tax-deductible contributions, so residents can reduce the amount of their taxable income if they invest in a 529 savings plan.
You can also choose to invest for your child’s education using a brokerage account or a 529 prepaid tuition plan. These are less popular options, however.
If you go for a 529 prepaid tuition plan, you pay tuition at some colleges at today’s rates. In doing so, you hedge against inflation and rising tuition fees. While you can transfer your funds if your child chooses to attend another college, prepaid tuition plans have their drawbacks: there are only 18 state sponsored plans that offer this, you need to be a resident of there. ‘State and they don’t cover additional education costs like 529 savings plans do.
You might also consider investing your money in a brokerage account through companies like TD Ameritrade, E * TRADE, or Vanguard. If you go this route, however, you will forgo some of the tax benefits you would get if you invested in a 529 savings plan. Namely, you will have to pay taxes when you sell any of your funds or stocks that the value has increased.
At the end of the line
There’s no denying that the cost of a college education is rising rapidly – even the thought of paying for it can be daunting for many parents. However, parents should start saving as early as possible so that they can reap more benefits from their investments.
Once parents determine what percentage of their child’s college education they are willing to pay, they can create a plan for their monthly contributions. They will have the option of investing in a 529 savings plan, brokerage account, or prepaid tuition plan, but they will likely get the most tax benefits and flexibility from a 529 savings plan.
Catch up on Select’s in-depth coverage of personal finances, technology and tools, well-being and more, and follow us on Facebook, Instagram and Twitter to stay up to date.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.