Define your education savings goals
Before you begin to invest, you need to define your savings goals. Decide how much you need to save by the time the child will reach college age. You could choose a specific dollar amount, such as the projected cost of public college tuition by the time your child is ready for college. Or you could choose to devote a fixed percentage of your income to your children's future college costs. Whatever you do, you should have a clearly defined goal, so that you can plan how to reach that goal and measure your progress toward that goal. Having a goal will help motivate you to save.
When to Start Saving
You should save as much as you can, even if it is only $25 or $50 a month, and you should start saving as soon as you can. Put the power of time to work for you.
The sooner you start saving, the more time there'll be for compound interest to build up a nice college fund for your children. A family that starts saving $10 a week at birth at 4% interest (really low) will accumulate $12,663.44 by the time the child turns 17 and enrolls in college. If the family waits until 4 years before college to start saving, they'll have to save $56.12 a week in order to reach the same goal. If the family waits until the year before college to start saving, they'll have to save $238.60 a week to reach the same goal. Note that the family that starts saving at birth gets 30% of their saving goal from interest compounding, while the families that starts saving when the child enters high school gets a little less than 8% of their savings goal from interest. Time is your most precious asset; don't squander it.
The best time to start saving is at birth. But if you haven't started saving yet, the best time to start is right now. It is never too late to start saving.
How Much to Save
When parents first start trying to decide how much to save, they often get overwhelmed by the cost of a college education. Four years of college for their children will cost four to seven times as much as their own education cost their parents. Even in constant dollars that's two to four times as much. For a child born today, their college education will probably cost three to four times as much as it costs today.
Remember that you don't need to save the full amount. A good rule of thumb is the one-third rule. This rule states that you should expect to save one third of the expected college costs, pay one third from current income and financial aid during the college years, and borrow one third using a combination of parent and student loans. Effectively, one third will be coming from past income (savings), one third from current income, and one third from future income (loans), letting you spread the cost of a college education over an extended period of time.
Given that long-term tuition inflation is 8%, children born today will pay at least three times current college costs by the time they matriculate. Combining this with the one-third rule, it follows that parents of a newborn should use current college prices as a goal for their college savings.
Besides the one-third rule, a few other good rules of thumb for deciding how much to save are as follows:
- Try to save at least $100 per month per child from birth. With a decent return (10%), you could accumulate almost $60,000 in 18 years. Up that amount by just $30 per month and you'll net close to $100,000 in savings
- If your state offers a tax deduction for contributions to section 529 plans, maximize your tax deduction.
- Base your savings goal on paying full freight at a public college in your state. This should be a little less than half the cost of the most expensive private college, offering you a more reasonable goal. This is a good proxy for what your net costs after financial aid will be at a more expensive college.
Try to avoid being overwhelmed by the numbers. Save whatever you can, even if it is just $25 to $50 a month.
The more you can save, the better off you'll be. Saving just $25 a week from birth to age 17 at 5% interest will yield $34,839.45, a nice college fund.
If you want to be more specific about your savings goals, then you might consider using the Vanguard College Savings calculator. It is rather lengthy, but it does allow you to consider and change various factors and derive a result that should meet your goals.
Step 5 - Assess Your Financial Situation