Welcome to MainStreet's newest series. Each week, we will answer a real question from readers on education costs and how to pay for college. If you have a question, feel free to send it to email@example.com.
Q: "I have two young girls, aged 9 months and 2 years and 9 months. How soon is too soon to open an educational savings fund for them? And what’s a good way to decide how much money to put in a fund each year?” - Amanda, San Francisco
A: It is never too soon to start saving for your children’s college education. The sooner you start saving, the more your savings will grow through compounding.
Suppose you save $250 a month for 10 years at a 5% average return on investment. You’ll accumulate $38,982, of which $8,982 is from earnings and $30,000 is from your contributions. Almost a quarter of your savings plan balance (23%) is from the earnings.
If you contribute the same amount, but spread it out over only five years — $500 a month for five years — you’d accumulate $34,145, of which $4,145 is from earnings. You contributed the same amount of money to the savings plan, but earned $4,837 less because you were saving for a shorter period of time. Less than one-eighth of your savings plan balance (12%) is from the earnings.Parents who start saving from their child’s birth typically end up with more than a third of their savings goal coming from earnings. On the other hand, parents who wait until their children enter high school to start saving find that only about one-tenth of their savings goal comes from the earnings.
On the flip side of the coin, it is never too late to start. Even if you start late, you will still benefit financially. Every dollar you save is a dollar less you have to borrow. And since every dollar you borrow will cost about two dollars by the time you’ve paid off the loan, it is literally cheaper to save than to borrow.
Your first step in setting up a college savings plan is to determine a college savings goal. How much money will you need to pay for your children’s college education? Will the girls be enrolling in a two-year school or a four-year college? Will they be enrolling in an in-state public college or a private college? Admittedly, it’s hard to predict what your children will do next week, let alone 17 years in the future.