College – Dumb Wealth

I’ll have to admit that I’ve thought and re-thought about how I should invest my kids’ education money. I feel an extra sense of responsibility because I don’t consider the money ‘mine’.

While I control the account and I can get the money back now or if the kids don’t go to school, for its intended purpose – funding an education – it’s not mine anymore, and that’s how I treat it.

If I allocated $20,000 towards my childrens’ education, the last thing I want is for them to end up with less than $20,000. The second-last thing I want is the stress of trying to earn back losses. While some argue that kids can take on debt to fund their education, I’ve seen how huge college debts can be debilitating. When a fresh graduate needs to start repaying big student loans within six months of graduating, they don’t have the time to be picky. They take the first decent job they can get and become debt-slaves for the rest of their lives. Many probably won’t be debt-free again until retirement – and debt is the antithesis to freedom.

Student loans –> credit cards –> car loans –> mortgage

Everyone I know who graduated with big student loan debts has not lived a free life. All these people have dreamt about ‘doing what they love’ but none could because they could never get a break from their debt repayments. I don’t want my kids to go through that.

So, if I put in $20k I want my kids to receive at least $20k. Of course, if invested in equities the probability that I accomplish this rises with my kids’ investing time horizon. Research has shown that very few historical 5yr equity market returns are negative.

How do you invest within an RESP?

The first step is simple. Simply put money into an RESP account and get that sweet, sweet Canadian Education Savings Grant (CESG) of up to $500 per child per year. This easy first step nets an instant 20% ROI.

Next, consider when your child(ren) will need the money. If it’s in less than 5 years I would suggest being very conservative. More than 5 years? Then you can start to take a little more risk.

Personally, I add an extra layer of conservatism on top of my baseline allocation. For example, if I considered a baseline allocation for a particular person with a 7 year time horizon to be 70/30 then I might ratchet down to 60/40. Also, within this mix, despite ridiculously low rates, I consider an allocation to risk free deposits (high interest savings accounts, GICs, CDs).

I know I’ll get flack for being too conservative, but I do this because time-lines are fixed. When a child graduates from high school they immediately (usually) go to college and have to pay a fixed cost. In contrast, I can delay retirement or adjust my expenses to live off less if I mess up my retirement account.

A friend of mine (let’s call her ‘Jane’) recently brought up the cost of putting her children through college. It turned out she was paying all the bills.

This would be great if she could afford it.

But she can’t.

Jane is 51 years old and earns roughly $90,000 per year. She will likely happily work for another 15 years. Currently she has about $400,000 in retirement savings and plans to aggressively save during her remaining working years.

To help her children pay for college, she has withdrawn some of her savings and tapped into a line of credit.

As a parent, I can understand the instinct to do everything you can for your children. However, I don’t believe parents should put their retirement at risk to pay for their kids’ education.

I realize I’ve probably ticked off a few people.

What is the parental obligation?

The moral argument that parents are obligated to provide an education for their children is strong. I agree that people shouldn’t have kids if they’re not willing to set them up for the world. However, what that means has evolved over the decades. Today that might mean a masters degree. But what were parental obligations 50 years ago? And what will they be 50 years from now?

The parental obligation seems to have grown over the years. Regardless, parents with college aged children today should have known what they were getting into, but at what point does the obligation end? Maybe never. I don’t know.

Of course, the decision is more than moral. It’s pragmatic. Money doesn’t appear out of thin air, and for that reason there are many additional considerations.

Who’s paying for retirement then?

Let’s put the moral argument to the side.

There is a pressing financial issue facing parents today. The cost of post-secondary education continues to rise faster than incomes. While it is increasingly necessary to get a college education, it is also increasingly financially unattainable for many people.

This is happening while much of the world faces a retirement crisis. People simply have not saved for retirement. Jane is one of the lucky ones, yet she still faces a shortfall if she doesn’t continue to aggressively save and invest.

Jane’s ability to fund her retirement is at odds with her desire to pay for her children’s education. She probably cannot do both.

Her window of opportunity to remain self-sufficient in retirement is closing. The more she financially commits to her children’s education the less likely she will retire as planned. Of course, plans have a way of going wrong anyway. Any number of unexpected events – ill health, redundancy – can cut her timeline to retirement in half. Jane has limited time and lots of downside risk.

In contrast, her children will have 60 years ahead of them once they graduate from college. If they pay for their own education, this is plenty of time to repay debts. If they pursue the right career path, they likely have much more upside than Jane has downside. Moreover, if Jane’s retirement is adequately financed she will retain independence. If Jane sacrifices her retirement to pay for her children’s education she will invariable depend on them (perhaps even live with them) once she stops working. Whether this is good or bad is up to the family to decide, but you must recognize that each option comes with trade-offs.

The biggest trade-off for Jane’s kids if they self-fund their education is they will be saddled with debt on day 1 of their working lives. That seriously restricts their ability to take entrepreneurial risk. It also forces them to take the first job that comes their way, perhaps sending them down a path they didn’t envision. Debt is restrictive and stifling.

As you can see there are no clear cut answers (unless you’re rich), but here is what I think:

The decision to go to college and pursue a stream must be carefully evaluated. College is simply too expensive to use as a place to find yourself. Students (and parents) must have a path in mind and need to fully understand the return on investment of a college degree.
Education costs should be shared by both parents and children. Everyone needs a stake in the game. Not only does this reduce the burden, I believe it builds commitment. The more a student is aware of the difficulty in paying for college, the harder they’ll work to get the most out of their education.
Avoid paying for college using debt. If any debt must be incurred, the child should borrow (not the parent). The downside risk for a middle-income, middle-aged parent struggling to save for retirement is simply too large.
Prepare well in advance. In anticipation of college costs (even if the child is still a toddler) cut some expenses. Forgo a trip or two. Importantly, the child must participate in these sacrifices starting at an early age. And when they can get a part time job, a significant portion of their earnings should be stashed away for school.

I don’t have all the answers, but I hope I have provoked some discussion.

Student loans –> credit cards –> car loans –> mortgage

How do you invest within an RESP?

What is the parental obligation?

Who’s paying for retirement then?

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