This “Ask an Ex-Banker” question came from reader Todd R. In response to earlier posts about the cost of college education, he wanted to calculate the following:
“If a family was sending their child to college this fall, AND they were fully able to pay cash (from an educational tax deferred plan) what would their monthly contributions look like for the previous eighteen years?
Assumptions – gross household income in 2014 is $100,000, and was steady but average 2% less each previous year.
Total annual expense $40,000 year one (includes living expenses). Expense increases by 3% each year.
Student earns degree in 4 years. Returns would track S&P 500 (or other index) to keep it simple.
18 years ago, this disciplined family started socking away $X each month in preparation?” –Todd R.
We could calculate this a few different ways, some easy and some complex.
I’ll start with the easy.
Simplest answer: $4,990 per year, or approximately $416/month.
Let me break down this simplest calculation to show the assumptions underlying it.
I assume each contribution is made on the first day of the year, and each contribution enjoys a full years’ growth at the assumed rate of return.
I assume the family makes 18 years’ worth of contributions to an education fund, starting in the year of the child’s birth and continuing non-stop through matriculation at college. I assume the family continues to fund the same amount in years 19, 20, 21 and 22, but that money does not get any return on investment. It just goes toward expenses.
I assume the costs of college, in years 19, 20, 21 and 22 are $40,000, $41,200, $42,436, and $43,709, respectively, reflecting the annual 3% rise listed in your scenario.
I assume a steady, 5% return on investment, every year, year in and year out, for 18 years.
I’ve ignored the income portion of your scenario for the moment.
After this I’ll update with other ways to answer the question, but I think this is a reasonable first approximation.
One concluding, scary, thought: NOBODY I know is saving $416 per month, from the month of their child’s birth.
Please also see related posts:
Interview with College Advisor Part I – The insanely rising cost of college
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