Child Education Fund Planning

"Can I afford to send my child to college?" It is a question every parent has in mind. Although the answer hopefully is yes, you will have to plan ahead. Unless you are very well off financially, you cannot expect to do nothing for years, and then suddenly find the funds to pay for college when your child is ready to go. The best thing to do is to start saving as early as possible, even if you’re able to save only a small amount at the beginning.

What expenses are included in the annual cost of college?
In general, the annual cost of college simply refers to tuition and room and board. However, to be more precise, there are five categories of expenses to determine the cost of attendance at a particular college:

Tuition and fees: Usually the same for all students (International students and local students can be different)
Books and supplies: Depending on the field of studies and requirements, it can vary by
student.
Room and Board: Depending on the meal plan selected, and whether a student lives on or off campus, it can vary by student.
Transportation: Depending on where a student lives in relation to the school. Overseas students may incur additional expenses to visit home countries. It can vary by student.
Personal expenses: It varies by student. (e.g. Health insurance, telephone bills, entertainment)

The last four categories depend on individual students. Thus, your child’s actual expenses may be slightly less than or more than the cost you find from the respective colleges’ websites.

How much will college cost in the future?

The key word here is “future”. Once you decide where you would like your child to receive his/her education, you can find the average cost in today’s value. However, since your child is not going to college now, the amount of expenses to attend college in the future is very likely more than today’s expenses. This is due to price increases in living expenses and tuition fees. For example, the average attendance cost (tuition and living expenses) of a four-year private college in Malaysia is RM$80,000 (source: Public Mutual University Cost Guide 2007). This amount will become RM$148,599 after 18 years if the inflation rate is 3.5% p.a. Thus, when calculating the future college cost, you must include the inflation in your projection.

Chart 1: College cost of RM$80,000 will become RM$148,599 after 18 years from now at an inflation rate of 3.5% p.a.

How much should I save?
Basically, you will want to put aside as much money as possible in your child’s education fund. The more money you put aside now, the less you or your child will need to borrow later. Start by estimating your child’s education cost for four years of college. Then, decide how much of the bill you want to fund, i.e. 100%, 75%, 50%, and so on. With the future amount of education fund determined, you have established a financial goal.

Depending on your own risk profile, you may put aside regular savings into investment portfolio that potentially yield high return (with higher risk of losing money) or put aside regular savings into Fixed Deposit that yield low return (with low risk of losing money). Alternatively, you can choose a moderate return with moderate risk investment portfolio. A same amount of money put aside regularly into different investment portfolio will yield different amount of fund at the end of the day. Chart 1 shows potential college funds that can be accumulated for conservative (4% p.a.), moderate (6%) and moderately aggressive (8% p.a.) portfolios at the end of 18 years. Lower return will reduce the college fund available in the future. To compensate for the shortfalls, you will have to put aside more money if you choose a lower return investment tool. Ideally, you want to put aside an amount of money that is affordable, regularly, into investment tools that match your investment risk profile. At the same time, the investment should be able to create a college fund that matches or more than the amount that your child will need when he/she is ready to go to college.

In reality, the amount of money you can contribute boils down to how much you can afford to contribute. There are too many competing financial needs for you and your family, such as retirement, buying a new house, changing a new car, vacations, and etc. If you find that you cannot afford to contribute as much as you plan to, you will need to take a detailed look at your family’s finances in order to determine what expenses are optional, and reprioritize other competing financial goals. Ask yourself questions like: “Do I need to change car?”, “Can I just have one car instead of two?”, “Can I eat out less?”, “Do I want to spend my unanticipated windfalls like bonuses, or raises on a new 40’ plasma TV or iPhone?”

Start a savings program as early as possible
Perhaps the most difficult time to start a college savings program is when your child is young. New parents face a lot of financial strains such as the possible loss of one income, child-related spending, and the competing needs to save for a house or car. However, this is the time when you should start saving.

When you start early, you have many years to go until your child starts college. Thus, you have the option to select an investment that has the potential to outpace college cost increases, i.e. investment return that outpace the college cost inflation (but keep in mind that investments that offer higher potential returns may come with greater risk of loss). Another benefit of starting early is compounding effect of your money. It means the return of your investment in the past will be able to earn interest/return in the future. When you start early, your money can compound for longer time before you need it. The following chart shows how early start can make a big difference in the future. It does not matter if you cannot afford the amount that you suppose to put aside now. You can put aside as low as $100 per month and later increase the amount when you can afford it. This is better than doing nothing now because delaying will only cost you more in the future.

Chart 2: If start saving $4,800 annually at annualized return of 6% now, the college fund goal can be achieved in 18 years. If start late (10 years later), the same amount of annual saving and return will not meet the college fund goal compared to starting now. To cover the shortfalls, one will need to either put aside more money or choose an investment that has higher potential return at higher risk to catch up.

How can I fund the college fund?
This is also one important question parents always have. Should I put aside the money in unit trust investment, bank saving, stock, property or in an education insurance plan? There is no one answer for everyone. In fact, usually parents will need a hybrid solution. This is a balancing act of risk, investment return, and investment horizon.

Risk: We can plan everything, but we must understand that we made a couple of assumptions during the planning. We assume inflation rate unchanged. We pick the average college expenses that may be more or less than the actual cost. We also assume that the source of funding will not be interrupted, and there is no currency fluctuation.
Investment Return: It is not a guarantee return. Although we can manage the investment portfolio risk, the actual investment return always boils down to the market conditions that are out of our control. High return usually comes with higher risks, and lower return will have relatively lower risks.
Investment Horizon: If you start early, your investment horizon is longer. Hence, you can have more options with the same amount of budget. You may choose a lower risk investment tools, and still be able to achieve your goal. Alternatively, you can take higher risk since you do not need the fund in short term. However, if you start late, the remaining time before your child go to college is shorter. With the same budget, your only hope is to put your money to work harder for you. However, that also means you need to take a higher investment risk. In fact, when your investment horizon is short, you should put in more money rather than taking higher investment risk. This is because you will need the money in a few more years. You want to make sure that the money will be there when you need it and not subject to investment lost due to high investment risk.

The following table shows various investment options and the respective risk, return, and investment horizon. It is also good to know that education insurance investment allows you some tax relief. This tax saving may enhance your return if you put the saving back to the college fund. (The tax relief, SSPN, and EPF is only applicable in Malaysia, please ignore them if you are not from Malaysia)

Table 1: Investment tools available for preparing college fund

Note:
* Skim Simpanan Pendidikan Nasional
** Low means annual return less than 4%, moderate 4%-8% and high above 8%
*** No guarantee of getting

Labels: Education