Tuition by Intuition?

In a perfect world, we’d all be able to predict how much it would cost to send our kids to college and we’d be able to save that amount in advance.

In the real world, predicting how much college will cost is an imperfect art. Colleges make it difficult by changing tuition and fees by irregular amounts at unpredictable intervals. The federal government exaggerates the problem by periodically changing the rules governing who can qualify for student aid--and how much they’ll get. Our kids make it impossible by refusing at birth to make it clear whether or not they’re Ivy League material.

By the time it’s clear what college is going to cost, it’s way too late to start saving. What do you do?

You make a guess based on historic costs, what you want for your child and what you are willing to pay for. If an Ivy League school is very important to you, you should try to save at least three times as much as someone who is content with sending their child to a public college or university.

Also consider your attitude about paying for school. Many parents want their children to contribute to their own education on the theory that the education will mean more to those who’ve made a few sacrifices to get it.

If that’s the case, you can save less. But you’ll need to encourage your child to start saving a portion of his or her earnings--or allowance--when they’re very young.

When you start saving early, you can put your money in “volatile” investments, such as growth stocks. Volatility means you can make a lot of money one year and lose a lot of money the next. It means you are taking more risk with your money. Why would you want to do that? Because taking reasoned risks allows you to reap higher rewards. That means the college fund grows faster than it would if you invest the money conservatively.

Still, many people hesitate to take reasonable risks because they’ve been told that they shouldn’t gamble with their money. That’s true if you’re investing the rent money.

But a college fund isn’t rent money. Many kids have made it through graduate school without a dime in the college coffers. Clearly, that’s not ideal. But no one’s going to turn the lights out, your kids are not going to sleep in the streets, and the family is not going to have to live on food stamps if you face an investment loss in the college fund.

Starting early and taking a few calculated investment risks allows you to reap the very real and very dramatic rewards of long-term compounded returns.

Consider someone who wants a $10,000 college fund for their child. If the child is a newborn, they can reasonably expect to earn an average annual return of 10% by investing the money in domestic stocks. (That’s the average annual return of large company stocks from 1926 through 1994; the average return on small company stocks is higher.)

As a result, this family can put away just $17 a month--a total of $3,672--and 17 years of compounded investment earnings will provide the rest--some $6,328, or nearly twice as much as they saved.

If, on the other hand, the child is 15 and college costs are looming near on the horizon, this family would be foolish to take as many risks. They will have to invest more conservatively, accept lower average returns, and their money will have less time to work for them.

The procrastinators will invest in short-term Treasuries, bank deposits and certificates of deposit. In today’s market, their expected annual return would amount to less than 7%. They’d have to save $250 a month for 36 months--a total of $9,016.

In other words, the family that saved early needed to save $5,344 less.

* Adapted with permission from “Kathy Kristof’s Complete Book of Dollars and Sense” (Macmillan).