09 Oct THE BEST WAY TO SAVE FOR COLLEGE: A FAIR TALE
From the time our children were born, my wife and I wanted to make sure they would have the resources available to seek a college education. We wanted to be as fair as possible in allocating family resources and not favor one over the other. However, as this tale will teach you, if you want to do what is best for them and your family, it is beyond your control. So sit back and let nature take its course, because you’re not in charge. You can control your actions, but the outcome is pure luck.
YOU CAN’T MEASURE FAIRNESS WITH MONEY
People have a need to be fair, especially with their children. A sure path to family dysfunction is to show blatant favoritism toward one child over another. Unfortunately, when dealing with your children, you can’t measure fairness with money. Doing the best for each of your children is the only way I know a parent can be fair. Why do I say this? Because life is far more complicated than what we can measure monetarily. Let me give you some examples that come up frequently. As the father of four children, I deal with the issue of fairness and money all the time. Like every other parent, I struggle with the notion of what is fair.
YOU WANT TO SAVE FOR COLLEGE
Let’s take the case of college planning. This is one of my favorites. Let’s assume that you have four children. It’s probably safe to assume they will be of different ages and have different interests. Let’s assume you want to save for college and that you invest $2,000 per year into an investment portfolio from the time each is born until the day they go to college. This alone throws off the entire concept of fairness. Why do I say this? It probably seems fair in terms of the actions you as a parent take. But, the result isn’t fair. When each of your children gets to age 18, they will have significantly different amounts in their portfolios. It’s common sense. Each portfolio will perform differently based on when you start each portfolio, even if you invest in the exact same thing and with the exact same amount.
Let’s examine my family and look at my children. They were born in 1985, 1987, 1991 and 1994. If, at the start of 1985, I had invested $2,000 in the S&P 500 and invested an additional $2,000 every year thereafter, by the time my son reached 18, he would have $104,178 in his account. Two years later, I start the same program for my daughter born in 1987. She would have $111,611 in her account when she reached 18. Next, I do the same thing for my daughter born in 1991, and she would have only $54,844 in her account when she reached 18. Finally, I do the same thing for my son born in 1994, and when he reached 18, he would have $59,639. How can this be? How is this fair? It isn’t fair from an outcome basis since the outcomes are entirely different. It is from a parental basis. In each case, we did the exact same thing for each child. We invested $2,000 per year in the exact same fund at the exact same time, for a total investment of $36,000. However, one child ended up with $111,611, and the other with less than half of that. What’s the answer? The answer is timing and luck. Timing matters, and don’t let anyone tell you otherwise. It’s why I say, “You may not be able to time the market, but it can certainly time you.” There are solutions to this market-timing problem, but they are beyond the scope of this book.
THIS ISN’T PREDICTABLE
This paragraph is for nerd island inhabitants and those looking to fund a college education who might be sitting down thinking this type of thing is predictable. It isn’t. If you were to do the same analysis from 1928 through the present, the results are startling. If you had started in the worst possible year, which was 1957, your 18 year old would only have $49,793. In the best possible year, which was 1982, your 18 year old would have $263,771, five times more. Put that in your hat when planning for college. Why was 1957 the worst year to start? It is because your child turned 18 at the end of 1974, which marked the end of a significant decline in the S&P 500. Why was 1982 the best year to start? It is because your child turned 18 at the end of 1999, which marked the end of a significant advance in the S&P 500.
This paragraph is for advanced nerd island inhabitants and those looking to fund their retirement who think this type of thing is predictable. Guess what, retirement planning is also unpredictable. I will use the case of my four children once again and assume one entered the workforce in 1970, the other in 1972, the next in 1976 and the last one in 1979. I picked these dates for a reason. It marks the exact range of ages for my four children in that they are two, four and three years apart. Once again, I assume each invested $2,000 per year in the S&P 500, but in this case, they do it for 30 years instead of 18, as you would do for college planning. When my son retires in 1999 after 30 years, he has $1,125,360. My daughter retires two years later, but she only has $760,090. My other daughter retires four years later with even less. She only has $501,142, and finally, when my youngest son retires in 2008, he only has $315,532. This is astounding, and the point of this all is that timing and luck matters greatly. There are a number of takeaways from this, but they are reserved for other tales.
TAKING SCHOLARSHIPS INTO ACCOUNT
Let’s get back to college planning and take it to the next level. Let’s assume that somehow you have found a way to equalize the outcome by adjusting the input. Now let’s assume that you have one child who earns a full scholarship to a private and expensive college, another who receives no scholarship and attends a public university, yet another who chooses to live at home and commute to a community college and the last who chooses to pursue opportunities outside of the college route. What is a parent to do in this case when it comes to fairness? There is no right answer to this quandary.
Let’s look at one more variable that influences fairness and college planning. The variable is the difference between what parents can save towards college at different stages in their life and career. The ability to save is therefore a variable. Many parents find they can’t save as much money when their children are young as they can when their children get older because of their financial position. Most people earn more money as they get older, and this is a natural progression. Is it fair to the first born who the parents couldn’t save as much for when he or she was born as they could when the last one came along? The reverse can also hold true. We all know that people experience setbacks in life. What if the parents can finance a college education for the older children but, due to a reversal of fortune, can’t for their younger children?
NO FAIRNESS WHEN IT’S TIME TO SAVE FOR COLLEGE
I think by now the concept of fairness and children from a monetary perspective cannot be quantified when it comes to college. Can we quantify the differences between sons and daughters? Is it fair to sons that parents may choose to pay for a daughter’s wedding? Again, there is no right answer to this question. The best a parent can do is their best. Sometimes you wish you could be as wise as King Solomon when making these family financial decisions. The allocation of capital to your children is not an easy one.
Let’s change the topic to estate planning. Upon your death, should you or can you leave each of your children an equal amount always? I have a client who, when he dies, will leave an estate that is only large enough to provide for the income needs of his son with a mental handicap, yet he has two other children. What is fair in this case? If he leaves his three children money in equal proportions, then the one will suffer. What’s fair? I have another client with two children, and one will surely blow 100% of their inheritance within a year. Is it fair to leave them equal amounts? I don’t think so. In a situation like this, I think it is smarter to set up an income stream for the spendthrift child instead of giving them a lump sum.
TAKE CARE OF YOURSELF BEFORE YOU SAVE FOR COLLEGE EDUCATIONS
This brings us to what I consider the single most important issue when it comes to fairness and children. Let me describe the issue in the form of a question. Is it fair to over-allocate resources to your children at the expense of your retirement? The answer is unequivocally no. Taking care of yourself and your future is everyone’s primary financial goal. Don’t let anyone tell you that providing for a child’s future is more important. It’s important, but not “more” important. Finding the right balance is difficult, and a good advisor is worth their weight in gold when it comes to helping you arrive at answers that suit your situation. A seasoned advisor will help you ask the correct questions and provide examples of how different people dealt with the same issues you face. There is no substitute for experience.
Lastly, the largest over-allocation of family funds typically goes to the education of children. This is especially true for college. If you compare costs in this arena to costs 40 years ago, the price of education is outrageous. Colleges have found the way to price-discriminate their services in such a way as to extract every last dime out of every parent and student. In some cases, I don’t think it is worth spending the money to have a college degree. This is especially true if the degree comes from a third-rate college and conveys a fourth-rate major. Since these tales are “evergreen,” I don’t want you to think I am saying this situation will persist indefinitely. What I am saying is that one should examine the purchase of a college degree the same way one would look at any other investment or purchase decision. As a parent and/or as a potential student, you must analyze the situation and make sure the payoff is there.