An Easy Way to Make College Affordable


Paying for college is a concern of many parents, and well it should be.  College debt is a concern of many graduates, and well it should be.  An issue is that the children of parents who decide to do something about paying for college by saving up money and doing without some things so that they will have at least some of the money needed for room and tuition end up with about the same amount of debt as those whose parents save nothing.  This is because colleges just raise the tuition for those children whose parents have saved.  OK, they actually reduce the tuition for those whose parents have not saved, but it is really the same thing.  Go into college with $50,000 in a college savings account and the college will figure that you can pay $50,000 more than someone without a savings account.
Now if the child with the $50,000 account came from parents who made $250,000 per year while the child without anything came from a family making $30,000 per year, the difference in tuition is understandable.  But often both families may make $80,000 per year.  One family just choose to maybe drive older cars or vacation locally so that they could put a few thousand dollars away each year into an Educational IRA, while the other family was trading in cars every few years and vacationing at Club Med, living for today and figuring that they would worry about college later.

              

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The issue with this system is that it encourages exactly the kind of behavior you don’t want.  It encourages spending and penalizes savings.  This means that more people show up at the financial aid office with no savings.  People are not foolish — they will find ways to go to college for less or for free if they can.  Why save up if there is no advantage?  As a result, not only do only children from poor backgrounds show up with nothing to contribute.  Many children of middle-class families who could have paid a significant portion of their own tuition and room-and-board show up as well without any savings.

Because colleges need to provide a lot of grants (as does the Federal Government) to prevent their colleges from being full of only the children of the wealthy who can float the tuition with their yearly income, they raise the base tuition so that those who can pay, pay more.  This provides more money for grants and scholarships, so long as people don’t decide it isn’t worth the cost and as long as all colleges do the same thing.  Because the cost is higher, however, it means fewer people are able to pay full tuition from income, which means more student debt and less people saving up since when the amount they can saved is dwarfed by the cost, they figure, “Why bother?”

So what is the easy solution to fix his issue?  Simple – stop using college savings when determining eligibility for tuition reductions and other grants.  Instead, base tuition rates purely on income.  Children who come from families with little income would still find a lower tuition bill that they can afford, but those from a family with a higher income will need to put away more money, use more of that income to cover tuition, and/or take out student loans.  Because tuition would be lower for everyone (since the colleges would be giving out less tuition aid because more people would be paying most or all of their bill), the cost would actually be lower for everyone.

Several colleges could also band together and establish a birth-to-college saving plan where parents could contribute an amount each year based on their income as their children grow with the guarantee that tuition and a certain portion of room-and-board would be covered for any of the colleges in the network.  This would eliminate the uncertainty we currently see when it comes to college tuition and also means that everyone will be paying what they can.  Parents whose children decide not to attend college could have their money returned with a reasonable interest rate applied.

So what do you think?  Would it work?  Do you have a better idea?  Let’s hear it!

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Would you Rather Have a Million Dollars, or a New Car Every Three Years?


Would you drive a used car until you were 55 if someone would pay you a million dollars to do so?  Understand this doesn’t mean driving a junker – just driving a four-year-old car until it was eight years old and then trading for another four-year-old car.  If you would take this deal – and I think that most people would – why would you go on buying new cars anyway?

The fact is, if you can save up and buy used cars for cash every four years, rather than taking on a new payment schedule and dropping deeper underwater with each new car loan, you can invest the savings and have over $1 million by the time you are 55 just from the savings on the car loans.  Even more insane, that $1 million will turn into $2 million by the time you are 62, $4 million by the time you are 69, and a cool $8 million by the time you are 76 (which will probably be the new retirement age, given current life expectancies).

How could this be so?  Two reasons: depreciation and interest.

Basically, any car will drop in value by 50% in four years.  This means that a new car which cost $30,000 will be worth about $15,000 in four years.  This means that the car will lose an average of $3750 per year during each of the first four years.  This, by the way, is if you sell it to another individual.  If you trade it in, you’ll be lucky if the dealer will give you $10,000 (because he wants to make a profit from the sale of your used car to someone else).

 

              

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The same depreciation rate is true when you buy a used car – it will still lose about 50% of its value over four years –  but because the price of the car is less, the depreciation loss per year will be less.  Let’s say you pick up that car someone else bought new for $30,000 after four years when it was worth $15,000.  Even if it drops in value to $7500 over the next four years, you’ll still only be losing $1,875 per year.  This means that you will save $1,875 per year, which you can invest.

The second reason that what seems like a small amount of savings can turn into a large amount of money in 35 years is compound interest.  Specifically, while you are paying interest when buying a car on payments, you are being paid interest when you are able to save money that would have been going to a car payment and invest.  If you were going to be paying 8% interest on a car loan, but instead pay cash for the car and invest the rest, you will be getting an effective interest rate of 20% on your money, assuming a 12% return on stocks.  This means that instead of working extra hours to pay the interest on your car loan, you will be making money for simply letting others use your money to build their businesses.

So before you fall into the trap of endless car payments, think about what that car payment is really costing you – millions of dollars over your lifetime.  Is that new car smell and 32,000-mile warranty really worth that?

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Is It Possible to Save for College?


About 16 years ago I sat down and predicted the growth of my son’s college savings account.  I was planning to put away $2,000 each year into an Educational Savings Account (ESA).  Using an investment calculator, and using an estimate of a 12% return (about the average return for the stock markets), I predicted I’d have about $140,000 by the time my son was ready to go to college.  With in-state tuition at about $12,000 per year, plus money for food and housing, I was figuring a cost of about $30,000 per year, so the ESA would at least get him through undergraduate school.  He could then do research/teaching/etc. to help fund grad school if he went, and hopefully get out debt-free or fairly close.  That was the plan.

              

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Unfortunately, then came the 2001-2003 stock market, where returns were low or negative.  Things finally picked up after the 2003 tax cuts (yes, tax cuts do spur the economy, despite what some Liberal pundits will tell you), but then stocks fell during the 2008 housing market crash.  Since that point things grew at a modest pace, until Trump was elected, from which point on things have been on fire.  Despite the fairly good markets from 2009 – 2016, and the great market over the last 10 months, my annualized rate-of-return has been around 3.5% instead of 12%.

So, sitting here with about two years until the first tuition bills come in, my son’s account has a little over $52,000 in it today, instead of the $108,000 I predicted.  This is enough to pay for about two years’-worth of college expenses, but not four.  Alternatively, it is enough to pay for tuition, but not for room-and-board.  This has left me with a big dilemma:

How should I invest for the next couple of years, if at all?

With less than two years remaining, if I really need the money in two years, I should really put it all into bank CDs.  I cannot predict what the markets will do over such a short period of time, and they have about a 1/3 chance of being lower in two years than they are today,  There is a small chance, maybe one in ten, that they will be 25% lower or more, meaning I may only have around $39,000.  Then again, if we do see some great returns over the next couple of years, for example if Trump is able to pass big tax cuts and spur the economy, I could get 20% returns and have almost $75,000 when the first tuition bill arrives.  Note that my original predictions assumed I stayed fully invested in stocks the whole time, which was probably a bad assumption due to the risk of doing so during the last couple of years.

Another question this raises, however, is

Is it possible for a middle-class family to really save up and pay for college?

Granted, perhaps we should have been putting $4,000 or $5,000 away each year, with $2,000 in an ESA and then the rest in taxable accounts or a 529 plan after we maxed out the ESA.   But I don’t see how most families who don’t make $150,000 per year could afford that.  I mean, we have been very disciplined compared to many people our age.  Despite having an income far less than $150,000 per year, we paid off our home about six or seven years ago, leaving a lot of free cash flow available that many families who keep a constant mortgage don’t have.  Frankly, I don’t know how families who keep a mortgage are able to pay for the things they buy.  (Maybe they don’t, since the median amount of debt families who have a credit card balance is $17,000, according to Nerdwallet.)  Paying for everything and not using credit, including the things that come up like medical bills and auto repairs, I’m really glad we don’t have that $1,000 or $1500 mortgage payment each month.

I do think that many families should be able to get their children through college debt-free or close to it, but saving up everything ahead of time may not be possible.  Once our son gets into college, we could direct some of our regular income towards his room-and-board.  He is also likely to get scholarships that will cover most or all of his tuition.  If he also gets a part-time job and makes $500 per month, that would cover about half of his room and board.  Still, it does make you wonder why college prices are so high that many people need to get loans to get through.

Luckily in our case (and good planning and hard work create luck), we have some resources beyond the ESA to help pay for college.  Because of this, I will probably keep the ESA fully invested in stocks, hoping that we’ll see a couple of good years to boost the account balance.  If we see a drop in the next couple of years, we can cover costs with other funds for the first year or two while we wait for the ESA to recover a bit.  Really we don’t need to assume we’ll need to tap the account right away.

So what do you think?  Is it possible for families making $80,000 per year to save up for college?  Are tuition costs worth the value of the product they provide?  Is it worth it to run up loans to pay for college?

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.