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Friday, September 24, 2010

The Total Money Makeover: College Funding

This is the ninth of twelve parts of a “book club” reading and discussion of Dave Ramsey’s The Total Money Makeover, where this book on debt reduction is teased apart and looked at in detail. This entry covers the tenth chapter, finishing on page 182. The next entry, covering the eleventh chapter, will appear on Monday.

When I was growing up, my mom didn’t save any money for me for college. Not because they were neglectful, but mostly because there weren’t resources for such saving.

Where are we at now? I’m doing just fine,This experience, when I reflect on it, makes me question the value of college savings. I do understand the benefits of helping my children through school, especially if they realize the value of it. However, if I were looking at things from a post-college perspective, I’d actually much happier that my mom be safely retired than I would be if they had floated a college bill and were still working.
For me, at least, it makes sense to focus on retirement savings and make absolutely sure that it’s covered before even considering college savings. I think we’re there.

What to Expect from College
Fiske Guide to Colleges 2011, 27E

Many parents seem to expect that once the kids are out the door to college, they’re well on their way to a lucrative career. Ha. On page 169:
If you are sending your kids to college because you want them to be guaranteed a job, success, or wealth, you will be dramatically let down. In some cases, the letdown won’t take long because as soon as they graduate they will move back in with you. Here me on this: college is great, but don’t expect too much from that degree. [...] Because we have turned a college degree into some kind of “genie in a bottle” formula to help us magically win at life, we go to amazingly stupid extremes to get one.
This kind of talk is anathema to some. How dare someone impugn the value of a college education!
Here’s the thing: the actual college education only teaches you a bit of what you’ll actually need to know in the workplace. The value of college comes in other areas: the relationships you build and the skills and ability to actually get through the minefield. The college degree merely says that you were able to navigate the minefield, not that you picked up invaluable knowledge that will help a business make money.

I found that the “cramming” skills most of my friends learned in college didn’t pay off until they secured a job. The relationships built paid off by helping them get their foot in the door for a big job interview, but most had other opportunities on the table that weren’t connected at all to those relationships. An actual college degree? It is a nice resume filler, but it was not what is going to get the job and it is not what will help you succeed when you get there.

Devaluing the Pedigree

Page 171 discusses the idea that where your degree comes from doesn’t matter that much:
In some areas of study and in a very few careers, where you graduate will matter, but in most it won’t. Pedigree means less and less in our work culture today.
The panic that people feel about how they “must” get into this certain college is completely overblown, from my perspective. You succeed or fail based on what you do and the relationships you build, not the environment around you. You can flame out just as well at MIT and at your local tiny state school. You can also succeed dramatically at both if you work at it.

I would far rather have a child that went to a small school without a great pedigree, took advantage of all of the opportunities there, built some great relationships with people, and got good grades in an area they’re passionate about than to go to Harvard and flunk out after two semesters.

Pedigree matters less. What matters more is the individual: did they take advantage of their opportunities, or let them idle around them?

College Lifestyle Adjustments

Dave riffs on this on page 171:
[T]hose precious kids can probably get a good degree if they will suffer through lifestyle adjustments and get a job while in school. Work is good for them. In past generations, students lived with relatives, slept in dorms, ate cafeteria food, and endured other hardships to get a degree.
I do not want the path my son have to college to be incredibly easy. For me, the aspects of college where you actually learn things were the areas where kids are pushed and challenged. Having everything paid for makes big swaths of college incredibly easy – and many college students, especially those lacking self-motivation, will fill those gaps with gratuitous wastes of time and money.

Obviously, the path shouldn’t be impossible, but no path that is a cake walk is one worth taking.

Tuition Inflation

College tuition goes up by leaps and bounds. On page 174:
College tuition goes up faster than regular inflation. Inflation of goods and services averages about 4 percent per year, while tuition inflation averages about 7 percent per year. When you save for college, you have to make at least 7 percent per year to keep up with the increases.
In other words, if you want your investment today to actually grow faster than the rate of tuition growth, you need to be making more than 7% on your return.

How can you do that? Well, there’s no guaranteed way to get that kind of return. However, if you start early in your child’s life, you have a period of almost twenty years to watch your dollars grow in a long-term investment, which means you can take on more risk than you could if your kid is fourteen.
 College Savings Calculator - Excel Spreadsheet

I have my son’s college savings almost entirely in stocks. As he is getting older, I’ve slowly begin to shift his savings towards bonds and safer things, but for now, the potential growth of the stock market and the time frame I have for saving makes stocks a great choice.

Will Baby Life Insurance Work?

I know of several grandparents who have written to Being Broke Sucks asking whether buying whole life insurance for their newly-born grandchildren is a good option. I told them no – I suggested starting their grandchild a 529 if they’re saving for college and if they really wanted life insurance they should buy a small term policy for the grandchild.

Dave seems to concur on page 174:
Baby life insurance, like Gerber or other Whole Life for babies to save for college, is a joke, averaging less than a 2 percent return.
Whole life insurance is never a good deal. If you’re tempted to invest in it, consider something different. Instead of dumping, say, $100 a month into a whole life policy, buy a similar insurance policy for $10 or so a month, then invest the other $90 or so into a dedicated investment – a 529, a Roth IRA, or even just a taxable account. Put it into index funds through Vanguard (that’s what I do with my dollars) and just sit back.

You will be ahead. Why? The $90 you’re investing in index funds won’t have commissions taken out – the cost of a typical index fund is about 0.2% a year, while whole life funds have commissions so large that they often eat the entirety of your first few years’ worth of contributions.

If you’re thinking about it, get the information and projections from your insurance salesman, step back, and run the numbers yourself. Compare your investment in that policy with an investment in an index fund like VFINX and see where things wind up.

What Kind of Account Should I Use?

On page 175, Dave points towards a Coverdell account:
I suggest funding college, or at least the first step of college, with an Educational Savings Account (ESA), funded in a growth-stock mutual fund.
An ESA is often referred to as a Coverdell, named after the late Senator Paul Coverdell.

What’s the difference? The Coverdell has the advantage of enabling you to choose your investments on your own instead of choosing among the plans offered by various states.

The big drawback to a Coverdell, from my perspective, is that it has to be used by age thirty or else given to a younger relative. I don’t like this at all, which leans me towards the 529. Many students who go on to graduate school often wind up in school past age thirty; others may make the choice to go back for a different degree after some years in the “real” world. If I invest in my child’s 529 and they have money left after getting that four year degree, I’d like it if that money sat around in case they chose to go back to graduate school or for another degree later on in life. That option is cut off with a Coverdell.

What I hope for is that my son will earn enough scholarships to cover his undergraduate degrees . If that happens, he can keep that 529 for any graduate work they might do.
How to Pay Zero Taxes, 2010
Do you have any other thoughts on this chapter of The Total Money Makeover? Please share them in the comments – and feel free to respond to any of my impressions as well. After all, a good book club is all about discussion!
On Monday, we’ll tackle the eleventh chapter – Pay Off the Home Mortgage.

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