Ask MAX: A dollar saved?

September 10, 2006

Dear MAX,

They say a dollar saved today is much more valuable than a dollar saved 10 years from now. So if that's true, if I manage to save only a small amount between now and the time my child is ready for college, will she have to borrow that much less for tuition?

Indianapolis, IN

Dear Lana,

The short answer is yes — saving now makes paying for anything later easier because time works to your advantage when saving. Save $1 today, and in ten years you'll have about $2.

The above math is a bit simplistic, because in ten years a dollar will only be worth about $0.78 because of inflation. It will be about as easy to come up with $1.28 in ten years as it will be to put aside $1 today — inflation means you'll be earning about 28% more in ten years without getting promoted. So why not wait to save? Problem is, college tuition will also be 28% more expensive in ten years — if not more than 28% given recent trends.

When you save, it's fairly easy to beat inflation in the long run. As the first example shows, you'll have $2 for every $1 you put aside at about a 7% annualized rate of return. Putting aside $2 in ten years will be harder than putting aside $1 today (unless you win the lottery in a few years…) because you probably won't be earning twice as much money.

I get worried when I hear “small amount” in your question. Don't think the magic of compounding will solve all future woes. Earning 7% a year will be difficult going forward. 7% may be the high end of the likely range of your future returns. You'll still need to save aggressively each year. Expect to have to save an entire year's tuition along the way. Growth of your savings account plus your daughter's student loans should carry your daughter through and help leave her with a manageable debt load at graduation.

One pitfall: don't save the money in your daughter's name — it could make qualifying for student aid (not just loans which almost anyone can get, but actual grants) difficult. This is the one case where saving now will mean your daughter will have to borrow more in the future!

Thanks for the question.


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