Activate Baby Step 5. Your mission, should you choose to accept it is to create financial independence for yourself by saving 15% of your income into retirement, putting money away for your child(s) college using tax-advantaged accounts such as a 529 Plan, Educational Savings Account (ESA) or UTMA (my personal favorite) and paying off your home early. For many of us, Baby Step 5 and 6 will end technically before Baby Step 4 is (should I be so bold as to ask Dave to reorder the steps? Ha! Never). Baby Step 6 will create a joyous memory that your family will never forget. The grass will feel different, and the bank gets no more of your monthly cash flow. However, ending Baby Step 5 is much less happy, in my opinion. It means parting with a lot of hard-earned money and watching your child gain a lot more independence, ready or not. However, if planned correctly, there need not be financial stress to compound the other stresses you'll inevitably face.
It's no secret that college costs have risen much faster than inflation over the past 40 years, increasing the financial burden on families as they set money aside and on graduates once they enter the workforce. And yet, there are numerous professional and personal benefits to pursuing higher education for those who wish to do so. Weighing the costs against the benefits while considering personal priorities and the broader economic picture makes college planning a complex topic.
There are many economic benefits to attaining higher levels of education
This is why saving for college is a core component of any financial plan alongside other major goals such as retirement or buying a home. With all of the market and economic uncertainty of the past decade, customizing a financial plan to each individual or household's needs, ideally with the guidance of a trusted advisor, has never been more important. What should those planning for college consider today?
The rapid increase in the cost of education has led many to question whether college is still worth the investment. An important reason tuitions have risen so rapidly is that the economic benefits of college and advanced degrees have grown even faster. According to the Bureau of Labor Statistics, job prospects improve as educational attainment increases. For example, the accompanying chart shows that unemployment rates were 6.2% for high school graduates but only 3.5% for those with 4-year bachelor's degrees. Similarly, the median annual earnings of those with high school diplomas was $40,450 compared to $66,700 for college graduates. Not surprisingly, these patterns continue for advanced degrees as well.
Of course, these statistics are averages that don't consider individual circumstances or differences within each education level. Pursuing college and advanced degrees may not be for everyone, and there are many personal factors that must be considered. For instance, today's very low unemployment rates may make the opportunity costs of attending a 4-year college less attractive to some, including those who attend trade schools or benefit from on-the-job training. In contrast, poor economic periods, such as during the global financial crisis, may make the benefits of college more pronounced. Dave Ramsey's friend Mike Rowe does incredible work around the wealth that can be created in the trades, not to mention the savings to be had from not having to attend a four-year college. You can read more about Mike Rowe and the path to success in the trades here.
Additionally, these particular statistics don't consider the choice of college major or type of employment. Clearly, those studying highly employable subjects, such as those related to engineering and financial services, will likely have greater job prospects. Please don't let your child study left-handed puppetry. If your child goes for the generic majors of psychology or sociology, we need to have an economic conversation with them about their plan to generate an ROI from those degrees (some people obviously do, but many work in unrelated fields). Regardless, the broad data make it clear that higher education has many economic benefits if done correctly.
The cost of a college education has risen much faster than inflation
The other side of the equation is that the sticker price of a college education has increased 800% over the past 40 years. Even after adjusting for inflation, the cost of college has increased dramatically across all types of institutions, as shown in the accompanying figure. The real, inflation-adjusted cost of a private 4-year college degree rose 176% from 1981 to 2021, while public universities saw prices climb 252%. The cost of 2-year degrees has increased more modestly but has still easily exceeded inflation in most years.
Unfortunately, these inflation rates for education have also outpaced wage gains. Thus, those saving for college will need to save earlier, save more, take advantage of investment returns, and borrow. Certain investment vehicles with tax benefits, such as 529 plans, have been created to encourage earlier college savings in order to take advantage of compound returns over time. Recent data by Sallie Mae suggest that the average household pays for 43% of the total cost of college with the parents' income/savings, 11% through the student's income/savings, 29% via scholarships, grants and relatives, and 18% through borrowing. Thus, how families and students decide to pay for and finance the cost of college requires a thorough understanding of their particular circumstances.
Student loans are a major burden on consumers
Unfortunately, borrowing for college often results in high levels of student loan debt upon graduation. At the individual level, this burden on graduates must be factored into every financial and career decision. In the worst case, it may mean that graduates are unable to take as many risks or pursue their true passions if it means they are unable to generate the steady income needed to repay their loans. Proverbs 22:7 says, "The rich rules over the poor, and the borrower is the slave of the lender (ESV)."
Student loans have ballooned over the past 20 years to $1.6 trillion at the aggregate level across the economy, outpacing other non-mortgage consumer debt. This has led to macroeconomic concerns, with some comparing the size of student loan debt to the subprime crisis prior to 2008. While it's difficult to say exactly how this will impact the economy, there are important differences to subprime loans such as grace periods, forbearance, parent cosigners, and more. Still, it's possible that high levels of student debt could act as a drag on the economy due to its influence on career decisions, reduced consumer spending, and more.
Of course, the student debt crisis has become a key political issue. The current administration recently sought to cancel up to $20,000 in federal student loans for qualified borrowers. However, the Supreme Court has ruled that this is an overstep of the executive branch and invalidated the action. Politics aside, this has resulted in uncertainty for those with student loan bills coming due.
The bottom line? Higher education continues to be extremely valuable from a financial and economic perspective. Deciding how to pay for college is an important component of any financial plan. Saving early, making appropriate investments, and using attractive vehicles, ideally with a trusted advisor's guidance, can help increase the odds of financial success. At Whitaker-Myers Wealth Managers, we have been talking about college savings a lot lately. That's because we have launched a new service through our Financial Coaching Team called "Debt Free College Savings Plan," where we will not only have a Financial Advisor help you determine the appropriate amount to save each month but also walk you through the tactical and business decisions that must be made for college. A great way to introduce your soon-to-be newly minted adult into the beautiful world of finances.
WHY COLLEGE PLANNING IS A CORE PART OF ANY FINANCIAL PLAN
July 15, 2023
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