RPF0101-Calculate_How_Much_For

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00:00:30.800 | Are you interested in sending your kids to college and trying to figure out how much you need to save towards that goal?

00:00:36.400 | Today I'm going to teach you how to do that calculation for yourself.

00:00:39.600 | ♪

00:00:56.000 | Welcome to the Radical Personal Finance Podcast. I thank you for being here.

00:00:59.200 | My name is Joshua Sheets and today is Wednesday, November 12, 2014.

00:01:04.000 | Continuing our Be Your Own Financial Planner with technical content series.

00:01:09.600 | And today we're continuing with college planning.

00:01:12.000 | No real philosophy today.

00:01:14.000 | I'm going to teach you the nuts and bolts of how to actually sit down and calculate how much you need to save for your child's college tuition.

00:01:20.400 | ♪

00:01:28.400 | This is actually one of the most commonly asked questions to a financial planner.

00:01:32.000 | And today I'm going to give you exactly the details that you need to sit down with nothing more than a pen, piece of paper, and a financial calculator.

00:01:39.200 | Which if you don't have one, you can download an app for your phone or you can use one online.

00:01:43.200 | Very easy to use.

00:01:44.800 | And figure out for yourself exactly the amount of money that you need to save.

00:01:48.400 | And I'll talk through with you that in detail.

00:01:51.600 | I think that will be helpful for you.

00:01:52.600 | So if you're a financial planning student or you're interested, I'll give you how to do the calculations for the CFP exam.

00:01:59.200 | But this will also be interesting to you even if you're a layperson.

00:02:01.800 | And don't worry, I think I can do this in a way that will convey the important point without being inapplicable to those of you who listen.

00:02:11.200 | Maybe while you're driving down the road or out for a run or something like that.

00:02:14.200 | So I'll try not to major too much on the numbers.

00:02:17.200 | Real quick announcement before we get going with that.

00:02:19.200 | So here's the update for you on iTunes.

00:02:22.200 | Got some instructions for you for those of you who listen to the show with any sort of Apple device that's using iTunes.

00:02:27.200 | And I apologize to those of you who don't use that.

00:02:30.200 | But in the world of podcasting, even though the growth of the percentage of the marketplace of Android users versus iOS users is massively different.

00:02:40.200 | Android being huge compared to iTunes still.

00:02:42.200 | In the podcasting space, there's a massive dominance of Apple iTunes media.

00:02:48.200 | And at the moment, none of you who are subscribed to the show are getting the update since Friday.

00:02:52.200 | Friday was the last show.

00:02:54.200 | So I thought I had this all fixed for you.

00:02:56.200 | But it turns out that I don't.

00:02:58.200 | I didn't.

00:02:59.200 | So what happened is over the weekend, I redirected my feed.

00:03:01.200 | And I thought I did it properly.

00:03:02.200 | I very carefully followed the instructions.

00:03:04.200 | But I made a rookie mistake.

00:03:06.200 | And in putting the redirect feed, I put HTTP twice.

00:03:11.200 | So HTTP colon, you know, slash, slash, HTTP colon.

00:03:14.200 | And that broke the feed for all of you using iTunes.

00:03:17.200 | That's about somewhere between, by my best guess, that's somewhere between 1,500 to 1,800 of you are subscribed to an old feed that's no longer updating.

00:03:29.200 | It's very simple.

00:03:30.200 | All you need to do is unsubscribe from the old feed.

00:03:32.200 | So unsubscribe from my show.

00:03:34.200 | You can do this on your phone or on iTunes desktop client.

00:03:37.200 | Just unsubscribe.

00:03:39.200 | Search for the show again in the iTunes store and then subscribe.

00:03:43.200 | And then from then on, everything will be working.

00:03:45.200 | But what happened is your subscription has pointed to a feed that's no longer working.

00:03:50.200 | So Friday's show, episode 98, was the final show.

00:03:53.200 | So I apologize.

00:03:55.200 | And I apologize in advance.

00:03:56.200 | I'm going to be repeating this on shows for at least a few weeks in hopes of getting this redirected over, getting most of you redirected to the new feed.

00:04:04.200 | It was a bummer.

00:04:05.200 | But, hey, that's what happens.

00:04:06.200 | You live and you learn.

00:04:07.200 | I've never done this before and I'm figuring it out.

00:04:09.200 | So let's go on to the topic of today's show.

00:04:12.200 | So today we're going to talk about how to calculate how much you need to pay for your child's college.

00:04:17.200 | Now the challenge with this, educational planning has so many moving parts that in my opinion it's one of the most complicated aspects of financial planning.

00:04:26.200 | It's extremely complicated.

00:04:28.200 | Not necessarily because it's technically complicated in most people's scenarios but because there are so many different influences on what you would choose to do.

00:04:37.200 | And every aspect of financial planning can be complicated or it can be simple.

00:04:42.200 | What happens though is people don't often appreciate how complicated the subject is and they latch on to the simplified explanation.

00:04:49.200 | So today I'm going to give you the simple math but I'm going to point out to you how that simple math can be confused if you don't understand the assumptions.

00:04:57.200 | Understand the assumptions behind it.

00:04:59.200 | Education planning is tough because you're dealing with, A, multiple parties.

00:05:03.200 | So you're dealing with a student and you're dealing with a parent or maybe parents or maybe grandparent or grandparents, maybe as many as four or six or eight of them or other benefactors.

00:05:15.200 | You're dealing with many people.

00:05:16.200 | So this in and of itself introduces complexity.

00:05:19.200 | If you're a single person and you're doing all of your own planning for yourself, you only have to convince yourself of the right move.

00:05:25.200 | But if you're a parent and you're trying to save for your child and the child is trying to figure out, "What do I do about college planning," et cetera, then you've got many people to please, parents, grandparents, kids.

00:05:38.200 | So there's a lot of people.

00:05:39.200 | Plus everybody is going to have different goals and visions depending on who they are and what their background is.

00:05:46.200 | So each parent involved in a child's life may have a different idea of what would be right and best for their child.

00:05:53.200 | The child may have a different idea and usually does from what's right for the parent and the grandparents will have their own ideas.

00:06:00.200 | So everyone's got different goals and visions.

00:06:02.200 | One person wants to go to college for a great education.

00:06:05.200 | Oftentimes the parent is saying, "I want you to go to college for the great education."

00:06:09.200 | And other times the student may be saying, "I want to go to college for fun, to have a college experience."

00:06:15.200 | So this complicates everything.

00:06:17.200 | You've got to deal with the aptitude of a child and whether or not college is a good fit for them.

00:06:22.200 | You've got to figure out if college is a good fit, what kind of college.

00:06:26.200 | There are many different kinds of colleges.

00:06:28.200 | There's an Ivy League university education in liberal arts.

00:06:31.200 | There is a trade school education.

00:06:34.200 | There is a community college education.

00:06:36.200 | Why are we going to school?

00:06:37.200 | So you've got all these differing, warring opinions also coming at a difficult time usually in most students' lives when they're trying to figure out, "Who am I?

00:06:46.200 | Where do I go?

00:06:47.200 | Where do I fit into the world?

00:06:48.200 | How do we do it?"

00:06:49.200 | With regard to how to finance it, there are so many options with financing, and we've got to work through all those different options and figure out what makes sense.

00:06:57.200 | What makes sense for the best good of the student?

00:07:00.200 | What makes sense for the best good of the parent?

00:07:02.200 | And so there's a bunch of issues all wrapped up into this one thing called college planning.

00:07:06.200 | And when you start to open that up and unpack it in real life, all of a sudden what seemed like a simple thing is no longer a simple thing anymore because of so many different influences.

00:07:17.200 | Then when you get to the actual financial point of it, there are so many options for how we can save and pay for college.

00:07:23.200 | So often what's usually thrown out is a college account.

00:07:26.200 | By that, maybe someone is thinking of a 529 plan.

00:07:29.200 | This is the most well-known option that people know about when it comes to college planning.

00:07:35.200 | So the question is 529 plan.

00:07:37.200 | Well, you can't just say that because there are two types of 529 plans.

00:07:40.200 | Are you talking about a prepaid tuition plan that's sponsored by your state or another state or are you talking about a college savings plan, which is more of an investment plan?

00:07:48.200 | By the way, one of the things that really annoys me, both types are 529 plans.

00:07:52.200 | They're governed by the same aspect of the code, but usually what happens in today's modern world is that most people who are pundits on the topic of finance talk about either the prepaid tuition program or the 529 plan.

00:08:05.200 | But that's wrong.

00:08:06.200 | They're both governed by the same section of the Internal Revenue Code, section 529, and that lays out for you in that section two different options, one for a state-sponsored prepaid tuition program and the other for a college savings program.

00:08:20.200 | But both are 529 plans, just a little pet peeve from Joshua today.

00:08:25.200 | I go back and forth because I try to – instead of sticking to my guns, I try to deal with what people usually know about.

00:08:33.200 | And so you'll hear me refer to them interchangeably, but there's a little bit of trivia for you.

00:08:37.200 | So are we going to use a 529 plan or maybe you're familiar with a Coverdell Educational Savings Account, an ESA, often referred to as an educational IRA because it's been around for a while and that's what a lot of people think about it.

00:08:50.200 | So are we talking about that?

00:08:51.200 | Or what about should we use an UTMA or an UGMA account?

00:08:55.200 | UTMA stands for Uniform Transfer to Minors Act and UGMA stands for Uniform Gift to Minors Act.

00:09:01.200 | So are we going to use one of those types of transfers from a parent to a child or from an adult to a minor and use an UTMA or an UGMA account?

00:09:08.200 | Are we going to use Series EE Educational Savings Bonds, which have their own unique tax characteristics?

00:09:15.200 | Or are we just going to use just some kind of taxable savings account, taxable investment account?

00:09:19.200 | Are you going to buy – I've worked with some clients that are going to buy a rental house for their kids to live in and rent out while they're in college or the rental house is designed with a rental income to fund their child's education.

00:09:28.200 | Are you going to do that?

00:09:29.200 | Or maybe you're going to do what I often will go to and use a Roth IRA to pay for your kid's college, something like that, or an IRA using the education exclusion and exception.

00:09:39.200 | So there's a bunch of different plans.

00:09:40.200 | And so now we've added all of those real-life issues of parent and control and vision and direction and what school.

00:09:47.200 | Now we add on all this complication of what type of account.

00:09:52.200 | Then we add another layer of complexity, which is how do we deal with – we all have a limited number of resources.

00:09:58.200 | This is a basic nature of economics.

00:10:00.200 | And how do we apply those resources?

00:10:02.200 | So the biggest one is as a parent and a financial planner, how does the parent choose how much to save for retirement versus how much to pay extra on their debt versus how much to put into their child's college education account?

00:10:15.200 | That's a big question and few people are effectively doing all of those things.

00:10:19.200 | Or how much of a difference is it going to make in the educational standing and the personal success and achievement of your child of how much you spend on their college education versus whether or not you should send them to a fancy elite private high school or whether or not you should do like Joshua says and pull your family out of school for a year and spend their college money sailing around the world on a family trip instead of them going to college?

00:10:43.200 | Or maybe they should go to a trade school.

00:10:45.200 | Maybe they shouldn't go to a trade school.

00:10:46.200 | Maybe they should start a business and should you maybe fund their business, help them buy a welder at the age of 15 so they can start a welding business or buy them a set of tools so they can start a carpentry business or buy them a fancy computer with the necessary software so they can start building a website or building coding skills or something like that.

00:11:08.200 | Or should we just pay for a new kitchen where the family can gather together more easily instead of the cramped, dusty old kitchen where no one wants to be.

00:11:16.200 | We'll build a beautiful, airy new kitchen where the family likes to gather and that will build the family dynamic and that will build a stronger cohesive family unit and that strong emotional foundation will better serve your child than paying for college tuition.

00:11:31.200 | This is the actual situation that parents really face.

00:11:36.200 | It's not a matter of sitting down and saying, "Oh, I just saved $184 a month."

00:11:41.200 | This is the actual situation and you've got to decide this for yourself.

00:11:45.200 | Plus, even worse, let's say you start saying, "What state am I going to live in?

00:11:49.200 | Am I saving for college in Florida and then I move out of Florida in our society, in the US American society?"

00:11:55.200 | We have a very mobile society moving all around the world – excuse me, all around the country and to different states routinely.

00:12:00.200 | This is normal in our society.

00:12:02.200 | Is my child suited for college?

00:12:04.200 | I touched on that.

00:12:05.200 | Is college even still going to be around in its current form?

00:12:10.200 | In my opinion, I've never seen – I've been saying this, my own opinion for a while obviously.

00:12:15.200 | We all do.

00:12:16.200 | But I've never seen as much clamor, as much discussion in the popular mainstream press around the cost of college and the lessening benefits as I've seen.

00:12:30.200 | I've been astounded by it because I always held this opinion that was kind of this freak out in the main – out of the mainstream opinion.

00:12:37.200 | I kind of get uncomfortable when I find out that I've got mainstream opinions because I think something is wrong.

00:12:42.200 | But I've always held this opinion.

00:12:44.200 | Now, my opinion is becoming mainstream.

00:12:46.200 | College is going to look very different 10 years from now.

00:12:48.200 | So I've got a one-year-old son.

00:12:49.200 | How do I plan 17 years from now?

00:12:52.200 | Is it even still going to be around?

00:12:54.200 | In today's world, I spend a lot of time on iTunes U and I listen to college classes.

00:12:58.200 | And I can get an Ivy League education quality just by listening for free.

00:13:03.200 | I don't get the certificate but I can get the quality of the education if that's what matters.

00:13:07.200 | With my podcast, I'm trying to deliver a world-class, master's-level financial planning education for free through my podcast.

00:13:16.200 | They're actually not for free since I just launched the members program.

00:13:18.200 | It's free to you.

00:13:19.200 | If you want to support it, join the membership program, RadicalPersonalFinance.com/membership.

00:13:23.200 | I'll mention it at the end of the show.

00:13:25.200 | Or is it better if my kid just goes down and gets an education at the library?

00:13:30.200 | There's a famous scene from the movie with Matt Damon called Good Will Hunting where Matt Damon is the very intelligent character and he's confronting and having essentially an ego fight with another guy in a bar to impress a girl.

00:13:44.200 | And he says, "You're an idiot basically who spent $150,000 on an education you could have gotten for $15 in late fees down at the local library."

00:13:52.200 | So what's the actual market value of the degree?

00:13:55.200 | You see that historically in our society over the last 50 years, the market value has been very high and is still, if you honestly look at the statistics, is still very high.

00:14:06.200 | But then is this causation?

00:14:08.200 | Is this correlation?

00:14:09.200 | Is the type of person who's more likely to go to college because that's a better fit actually the type of person who is more likely just simply to be financially successful?

00:14:18.200 | So is it actually that they're successful because of the college degree or is it just that the type of person who's likely to finish the college degree is likely to be successful?

00:14:26.200 | I don't know the answer.

00:14:28.200 | I'm suspicious that it's more that.

00:14:32.200 | It's more simply correlation than actual causation.

00:14:36.200 | But then again, who knows?

00:14:37.200 | And you see major corporations that are making the news that say, "We don't really pay much attention to the GPA that you earned in college."

00:14:43.200 | So you're always taught as a student, "Well, I got to have this great GPA."

00:14:46.200 | That's changing.

00:14:47.200 | Now, is it completely changed?

00:14:49.200 | I don't think so.

00:14:50.200 | I really don't.

00:14:51.200 | And I think those who completely say, "Oh, it doesn't matter," I'm not so comfortable with that yet at least.

00:14:58.200 | But I certainly get their point and I think it is in the process of changing.

00:15:03.200 | It's a lot of moving factors.

00:15:05.200 | Now, you might be led to believe if you've ever read a personal finance book or ever heard somebody read an article in some personal finance magazine that all you need to do is just open a college account, toss a certain amount of money into it, and you're done, right?

00:15:20.200 | Wrong.

00:15:22.200 | I'm going to explain the calculations and how to do them, and it's going to show you all the assumptions that you've got to decide on.

00:15:28.200 | And I believe that goal setting should always include careful financial calculations.

00:15:34.200 | There is a price tag to essentially every goal that we have, and you can figure that out if you sit down with a calculator and do it.

00:15:41.200 | I have yet to meet the person that I've consulted with at least who prior to my being there sat down and said to themselves, "I'm going to calculate how much I need to save for my kid's college."

00:15:51.200 | Every client, almost every parent that I worked with said, "Yeah, I want to save for my kid's college," and almost nobody had ever sat down with a calculator and said, "How much do I need?"

00:16:01.200 | Same thing with retirement.

00:16:02.200 | So many people say, "I want to retire."

00:16:04.200 | Nobody sits down with a calculator and says, "How much do I need?"

00:16:06.200 | So you've got to actually do the calculations.

00:16:09.200 | But what happens is those calculations are tough, and that's one major reason why people don't do it.

00:16:16.200 | A, they don't know how to do it because we don't teach finance.

00:16:19.200 | We teach algebraic equations, but we don't teach financial equations.

00:16:23.200 | What's more valuable, being able to solve for X?

00:16:25.200 | That's pretty cool.

00:16:26.200 | It's useful.

00:16:27.200 | But I don't ever use algebra, but I interact in the world of interest rates and compound interest and present value calculations and investment returns and time-weighted rates of return and dollar-weighted rates of return every day, and so do you.

00:16:41.200 | So we should spend more time teaching the math of finance than we do the math of calculus, in my opinion.

00:16:46.200 | Calculus is cool, but math of finance makes a bigger difference, and no one can do the math of finance, and it's not that tough.

00:16:52.200 | Now, what's the reason?

00:16:54.200 | I don't know.

00:16:55.200 | Maybe if you actually did the math of finance and we knew how to do it, then we wouldn't be able to get taken advantage of by some people who can do the math of finance, but I'll leave that for today.

00:17:06.200 | So many parents want to do this, but they don't know how to do it, and it's a real challenge.

00:17:13.200 | It's a real challenge for financial planners to effectively help parents plan for their kid's college because you have to deal with the emotion of the subject.

00:17:23.200 | Really, really tough.

00:17:25.200 | When you're a financial planner and you're working in an engagement with parents, it's very important that you not insult your clients.

00:17:31.200 | It's really tough, though, because sometimes clients say things that just simply don't make sense in the context of financial planning.

00:17:39.200 | And the balance of relationship between who's in control, who's being consulted, who's not gets very muddy.

00:17:49.200 | If you are in a sales-oriented scenario, which is what you're in basically unless the client – unless you as a client have already paid your planner money and said, "I'm here to take your advice," you're in some sort of a sales process.

00:18:03.200 | So therefore as a planner, you have the problem of saying, "How do I be gentle so that I work towards the sale of whatever is the appropriate sale, the sale of my services, the sale of a product, an investment product, an insurance product," whatever the situation is.

00:18:17.200 | And so you're trying to kind of be careful, but you're also trying to bring truth and reality.

00:18:22.200 | And bringing truth and reality, some people can do it effectively very bluntly and just don't have any tact.

00:18:29.200 | But it's a real challenge for most of us to do it in a way that is tactful where you don't just tick everybody off that you're working with, but yet you bring reality to the situation.

00:18:39.200 | And this is one – this is the toughest thing to deal with the emotion of planning for kids versus the logic of other things taking priority.

00:18:50.200 | The one you're probably familiar with is many parents will choose to prioritize the cost of their kid's college education over and above their own saving for their own financial independence and retirement plans.

00:19:02.200 | And this is really tough because logically it doesn't make any sense.

00:19:06.200 | The financial planner is prone to say, "Look, there is a lot of things that your kid can do for college."

00:19:12.200 | And they can go to night school.

00:19:14.200 | They can work their way through.

00:19:15.200 | They can go to community college.

00:19:16.200 | They can borrow.

00:19:17.200 | They can put money on student loans.

00:19:19.200 | They don't have to go to college.

00:19:20.200 | There's all kinds of options.

00:19:22.200 | But there are very few options for you if you wind up old and unable to work and you don't have any money to live on.

00:19:31.200 | But it doesn't – even though it sounds so simple and logically true, that's not how parents interpret it.

00:19:37.200 | College is really emotional for parents.

00:19:40.200 | And I think it's because of a few reasons.

00:19:42.200 | Number one, it's probably due to their desire, parents' desire to have their kids succeed more than they themselves have succeeded.

00:19:48.200 | So as parents, we pour out our lives trying to help our children to stand on our shoulders and correct the wrongs of our parents that we perceive

00:19:57.200 | and improve on the rights of our parents and try to build the next generation up to a higher level.

00:20:02.200 | And I think that's right and it's true.

00:20:04.200 | But the challenge is that perhaps as a parent, you might be a little bit disconnected with the realities of the new job market today

00:20:12.200 | versus the realities of 20 years ago or 30 years ago or 40 years ago.

00:20:16.200 | And this is happening more and more.

00:20:19.200 | So it's a different world that we live in than 20 years ago.

00:20:23.200 | Not as different as 80 years ago, but it's a different world than 20 years ago.

00:20:26.200 | And so the connection of college and the value of the college degree and the value of the college education

00:20:31.200 | and the actual transformative event of college is very, very different.

00:20:36.200 | This is especially tough when grandparents get into the picture.

00:20:39.200 | When my father went through college – my father is 40 years – 40-something years older than I am.

00:20:44.200 | My mom was 40 when she had me and my dad is a couple years older.

00:20:50.200 | So when my dad went through school, the caliber and the quality and the intensity of a college education

00:20:57.200 | from a pure educational standpoint was extremely different on average than it is today.

00:21:03.200 | There's good evidence to show that.

00:21:05.200 | Go and read some of the books on it.

00:21:07.200 | There's good evidence for that, that the actual academic caliber of the average college degree was very different than it was today.

00:21:13.200 | Anecdotally, I found this in speaking with many professors.

00:21:16.200 | Many professors at my alma mater for undergraduate degree would say that they have noticed that.

00:21:22.200 | Even recently I was intrigued when I was talking with professors at the American College

00:21:27.200 | and I was talking to them about their PhD program, and they had to introduce basically two refresher courses.

00:21:34.200 | One was in the area of statistics and I don't remember the context.

00:21:37.200 | The other was in, I think, research methods because they had to refresh students with some basic ability to be able to do academic work.

00:21:45.200 | Now part of that was due to the fact that they're working with students who have been out of school usually for quite a while.

00:21:51.200 | Many times it's financial planners who are returning to college after the fact,

00:21:54.200 | after they have a successful long career and they're returning back now and so they need to be refreshed.

00:22:00.200 | Most times though it's just basically due to the caliber of the standards, of the educational quality.

00:22:07.200 | People often forget that the field of education has as much competition,

00:22:12.200 | in some ways has as much competition as anything else, and there is in some ways a race to the bottom.

00:22:18.200 | Tuition prices are good, there's lots of money that brings in other people.

00:22:21.200 | Students often aren't going for the actual learning, they're going for the degree.

00:22:25.200 | And so there's a whole massive confluence of factors coming together that affect the industry.

00:22:31.200 | Also affecting my situation, my father has an engineering degree.

00:22:35.200 | I have a liberal arts business degree.

00:22:39.200 | There's a major difference in what he had to, the work that he had to do to get a degree in electrical engineering

00:22:44.200 | versus the work that I had to do to get a liberal arts business degree. Major difference.

00:22:49.200 | So if he's trying to give me counseling for the impact of college compared to,

00:22:56.200 | based upon his experience without having a more broad-based view of my situation and my world,

00:23:01.200 | that's really tough for a father to do.

00:23:03.200 | It's even tougher for a grandparent to do because the grandparent is often much farther removed.

00:23:09.200 | Then you've got to deal with what are the actual mental associations that the parent has with college.

00:23:15.200 | So for many people, college was a very transformative experience in their life,

00:23:19.200 | but not necessarily related to the education that they gained

00:23:25.200 | and not necessarily related to the job skills that they gained.

00:23:29.200 | If you were a hippie and you went through the '60s and the '70s, you went through college,

00:23:34.200 | that was a transformative, entire culture-changing experience.

00:23:39.200 | Or if you were a law student and this was your, you went, for you college meant

00:23:45.200 | this incredible personal transformation and a fight for justice.

00:23:50.200 | Maybe it was transformative in your political beliefs.

00:23:52.200 | For many people, the college experience, interacting with politics at a different level,

00:23:58.200 | it's a very transformative experience in their lives for political beliefs or religious beliefs or spiritual experience.

00:24:05.200 | Whether you're talking about that in the restrained religious sense or in the kind of not so conservative substance sense,

00:24:16.200 | it's a time of growing up.

00:24:19.200 | In our society, we coddle, in my opinion, we coddle children and we extend,

00:24:24.200 | we've created this thing called adolescence that has never existed in the history of the world until recently.

00:24:30.200 | Then we've extended that adolescence and finally, for the first time almost,

00:24:34.200 | some students at 18, 19, 20, 21 years old are forced to confront the realities of life.

00:24:39.200 | In my generation, my generation is so heavily protected by our parents

00:24:44.200 | that it's like the first time that you ever actually face a challenge.

00:24:48.200 | For previous generations, it was too.

00:24:50.200 | Maybe it's the first time you've been out of the house, out from under your parents' thumb

00:24:54.200 | and out from under their rules and finally able to express yourself and figure things out.

00:24:59.200 | Well, that does something deep in a person's psyche, in a parent's psyche.

00:25:04.200 | Many times, a parent wants their child to have that same transformative experience.

00:25:08.200 | So, this is a really difficult thing to deal with when you're dealing with as a planner

00:25:13.200 | and you're working with all of these emotions and you don't really know what they are.

00:25:18.200 | You're trying to kind of bring them out, but usually, it's kind of difficult to,

00:25:22.200 | in an initial financial planning engagement, to get a parent to open up about how college is a big deal for them

00:25:28.200 | and they're prioritizing it over retirement because that was the first time that they did LSD

00:25:32.200 | and had this amazing transformative out-of-body experience.

00:25:36.200 | It's a little bit difficult to get that to come out when there's not a level of trust,

00:25:40.200 | but yet, that is often one of the things that affects some people.

00:25:44.200 | So, with all of these strategies, with all of these influences,

00:25:48.200 | that's why some of my favorite strategies are actually the most flexible

00:25:52.200 | and don't actually – because they need to – because I believe we've got to account for flexibility.

00:25:56.200 | We've got to bring in and allow for flexibility because there are so many unknowns.

00:26:00.200 | Two of my favorite strategies for actually saving for college that I've recommended to many people

00:26:05.200 | is not to use a specific college account, but rather to use an IRA or Roth IRA,

00:26:10.200 | preferably a Roth in my scenario, and use that to save for your child's college

00:26:15.200 | or to focus and try to get a parent to save for retirement and then simply,

00:26:20.200 | if your child is going to go to college and once that situation gets closer,

00:26:24.200 | simply to stop the retirement contributions and pay for college out of cash flow.

00:26:28.200 | Now, this is technically, mathematically, in a perfect world, probably not the most optimal scenario.

00:26:35.200 | But in a real world, it's a much more flexible scenario that in my mind has a lot of advantages.

00:26:42.200 | So, many times, flexibility is more useful than mathematical optimization.

00:26:48.200 | So, I like strategies where people still have options and flexibility.

00:26:52.200 | And incidentally, this is actually what most parents wind up doing.

00:26:57.200 | If you are laboring under the idea that somehow all good parents have a college account set aside

00:27:05.200 | that's funded with $134,000 and it's just sitting there so that Johnny on his 18th birthday

00:27:09.200 | or Sally on her 17th birthday can say, "Here, Sally, here's your $140,000 college account.

00:27:16.200 | What college would you like to have saved all my money for?"

00:27:19.200 | Baloney. Doesn't happen.

00:27:21.200 | In the years, in the five and a half years I was a financial planner,

00:27:24.200 | I met probably two families that were in that situation.

00:27:27.200 | And even those two families that were in that situation, the scenario was so –

00:27:32.200 | it was still so uncertain that I'm not even certain that that was a benefit.

00:27:38.200 | So, if you're worried about that, don't.

00:27:41.200 | Most people, the way – my observation, my experience only, I can't prove this statistically.

00:27:46.200 | The way that most people handle college is many parents, A, struggle just with their own personal finances

00:27:52.200 | and they try to just get their kid launched and hope for financial aid and that's fine.

00:27:56.200 | Hopefully, we can improve that situation but that's fine.

00:27:59.200 | Some parents are able to set some money aside.

00:28:01.200 | Sometimes it's in a college account.

00:28:03.200 | Most often, it's usually one of the 529 prepaid tuition programs with the state

00:28:08.200 | which has advantages and disadvantages.

00:28:11.200 | So, that is one option and usually that's only going to be a partial scenario.

00:28:17.200 | But that is probably the most heavily funded because the way those programs work is you have to make that payment.

00:28:23.200 | And so the parents, because they have to, they do it.

00:28:25.200 | But oftentimes, that hurts other aspects of their finances.

00:28:28.200 | Or if they have some other savings, it's usually just a small amount of savings

00:28:32.200 | and they – parents that do pay often will pay out of cash flow.

00:28:35.200 | They'll reduce other expenses.

00:28:37.200 | Maybe by that time, they've gotten their mortgage paid off or they'll choose to drive not to incur a new car payment.

00:28:43.200 | And then at that point in time, they'll go ahead and just use that excess cash flow to put towards college

00:28:47.200 | or a lot of times, they'll cosign on student loans or the parents will take out student loans

00:28:52.200 | just simply from a cash management perspective.

00:28:54.200 | So, that's normal.

00:28:55.200 | So, don't labor under this false pretense.

00:28:57.200 | Everyone else is saving for college.

00:28:58.200 | So, therefore, I have.

00:28:59.200 | The competition the parents face is absurd.

00:29:01.200 | I'll tell you.

00:29:02.200 | They're not saving.

00:29:03.200 | Most people are not saving.

00:29:04.200 | That's why we get all these articles about how massive the student loan debts are because most parents are not.

00:29:09.200 | College – specifically college accounts can be useful.

00:29:13.200 | But they're not a panacea.

00:29:15.200 | They don't answer all the problems.

00:29:17.200 | I will explain them in detail.

00:29:19.200 | They are useful in their place.

00:29:21.200 | But before we get there, we're going to start with the math.

00:29:23.200 | And we're not going to actually talk too much about accounts today.

00:29:25.200 | We're going to talk about the math so that you can understand the assumptions behind the math

00:29:30.200 | so then you can figure out what's the right move for you from the perspective of a college savings account.

00:29:36.200 | Usually, you're going to be doing the math with some kind of software.

00:29:40.200 | There are a number of great calculators online you could use.

00:29:43.200 | And the calculators will in many ways make it easier for you.

00:29:45.200 | As a financial planner, you're going to be working with some type of software that makes this relatively simple.

00:29:50.200 | But I'm going to teach you how to do it manually.

00:29:52.200 | And I think this is important for a number of reasons.

00:29:54.200 | Number one, I think you need to know how to do it manually

00:29:58.200 | in order that you know what your software is doing or you never catch the mistakes.

00:30:02.200 | If you don't know what your software is doing, you don't catch the mistakes behind it.

00:30:06.200 | And that's a major problem because software is opaque.

00:30:09.200 | Whereas a series of calculations, you can go back and you can retrace your steps and you can find your problem.

00:30:15.200 | So you need to know how to do it manually so that you can then move on to doing software.

00:30:19.200 | An example for this would be we usually teach kids how to do math by hand

00:30:26.200 | and then introduce a calculator as a useful tool.

00:30:28.200 | And if you're using the calculator as a tool and it's on top of a strong knowledge of the ability to do it by hand, then it's great.

00:30:36.200 | But if the foundation is there – is not there with the basics of math, doing it by hand,

00:30:44.200 | then the calculator winds up always being a crutch and oftentimes the student can't work it properly.

00:30:49.200 | So number two, knowing what's going on in the calculations will actually force you to think about the plan and the assumptions you're using.

00:30:57.200 | As we go through the math, I'm going to come back at the end after I go through the steps to how to do the calculations.

00:31:03.200 | I'm going to show you all the assumptions that are involved.

00:31:05.200 | And what you're going to see is that these assumptions make a massive difference.

00:31:08.200 | So the ability to say, "Okay, Joshua, Mr. Financial Planner, tell me how much I need to save for my kids' college."

00:31:15.200 | Well, I first got to ask you about 19 questions.

00:31:18.200 | And then with those 19 questions, I can give you a specific to-the-penny answer.

00:31:22.200 | But if any of those 19 variables changes, then all of a sudden the answer changes.

00:31:28.200 | So you've got to know the plan and how it works in order to identify properly the assumptions.

00:31:33.200 | If you are going to be a financial planner, your ability to do simple planning like this on a legal pad or a napkin,

00:31:40.200 | instead of having to go back to your office and rely on the financial planning software,

00:31:45.200 | that's going to help you to open cases, more cases, and to serve clients better when they're still in the evaluation phase of the relationship.

00:31:53.200 | At the end of the day, a nice, well-prepared output from a nice software program is going to be much more helpful for a client to understand than the calculations on a legal pad.

00:32:03.200 | But if you can do the calculations on a legal pad, you'll get more opportunities to open cases with clients.

00:32:08.200 | And then that will help you to demonstrate that you're different, you know what you're doing.

00:32:14.200 | And then this is different at different phases in your career.

00:32:17.200 | In the beginning, your clients are going to spend a lot of time interviewing you.

00:32:21.200 | Towards later in your career, once you're established, you spend more time interviewing clients to see if they are a good fit for you and your practice, and it's different.

00:32:30.200 | I learned how to do it just because it made me feel cool because I thought it was a cool skill to have.

00:32:35.200 | And I don't discount that at all. I think it's nice to feel cool. It builds your self-esteem.

00:32:39.200 | And then finally, you need to know how to do this on the CFP exam.

00:32:42.200 | So if you're a financial planning student, you need to be able to do these calculations on the CFP exam.

00:32:47.200 | So how to run the college calculations.

00:32:50.200 | Basically, there are three calculations that you need to do, three different steps.

00:32:55.200 | Step one is you're going to calculate the cost of the first year of college based upon the inflation assumptions for the cost of college.

00:33:03.200 | Step two is you need to determine the exact amount of money that you need at the first year of college in order to fund all four years of college.

00:33:12.200 | And then step three, you need to determine then in order to fund that at the first year, you're going to back up to today, put in your assumptions, and understand how much you need to save on an ongoing basis, on a monthly basis, or in a lump sum today.

00:33:26.200 | So let me walk you through an example.

00:33:28.200 | And don't worry if you're listening in the car, I'm going to do the numbers, but don't worry too much about following them.

00:33:34.200 | I will put some notes, some basic notes in the show notes so you can just follow these calculations and you can do them yourselves, and I'll link to a financial calculator app that you can use.

00:33:43.200 | I don't want to -- I can't -- video is better for me to teach.

00:33:47.200 | Like here's the keystrokes, and it's going to differ depending on the type of calculator.

00:33:51.200 | But you could -- if you have a financial calculator, you can figure it out with this information.

00:33:56.200 | So step one, I'm going to use my scenario.

00:33:59.200 | I have a one-year-old son, and let's figure out a school.

00:34:02.200 | So first thing we got to do is we got to say -- we got to calculate what is the cost of the first -- what is it going to cost in the first year of college.

00:34:09.200 | So you can see the first decision.

00:34:11.200 | Well, where is my son or daughter going to go to college?

00:34:14.200 | Are they going to go to a local community college?

00:34:18.200 | Are they going to go to a big fancy private Ivy League school?

00:34:21.200 | That's going to make a difference.

00:34:24.200 | And I have no idea.

00:34:26.200 | And so you can see right here, this is where -- what stumps people.

00:34:29.200 | I have no idea where my son or daughter will go to college.

00:34:34.200 | I don't know.

00:34:36.200 | And you don't know either.

00:34:38.200 | No matter -- no matter how proud you are of your, you know, alma mater -- I don't even know any college mascots.

00:34:47.200 | But whatever the mascot is of your school, no matter how proud you are, you don't know that.

00:34:52.200 | So you do a guess.

00:34:54.200 | And this is what we practically do.

00:34:56.200 | We say, "Well, what would you guess?"

00:34:57.200 | So I'm going to use as an example the University of Florida.

00:34:59.200 | I never went there.

00:35:01.200 | But it's a state school here in the university, and my neighbor is obsessed.

00:35:05.200 | So they love University of Florida football games.

00:35:08.200 | So every time there's a University of Florida football game, there's a massive party and it's fun.

00:35:12.200 | So I looked up this morning -- University of Florida.

00:35:15.200 | I wanted to use a state school instead of a private school.

00:35:17.200 | So I looked up University of Florida, basic cost of attendance.

00:35:20.200 | And so currently, if I use the undergrad on or off campus fees, then University of Florida suggests planning on a budget of $20,550 per year for the year 2014-2015 for incoming freshmen.

00:35:39.200 | So $20,550 per year.

00:35:42.200 | Now, as far as what that includes, I'll tell you what that includes.

00:35:45.200 | That includes $6,310 of tuition and fees, $1,290 for books and supplies, $1,260 for a computer and a cell phone, $5,340 for housing, $4,290 for food, $1,100 for transportation, $690 for clothing and maintenance, and $270 for personal expenses.

00:36:13.200 | So you can see right there ways to adjust that number down, up.

00:36:17.200 | If your food budget is $4,290 and that also has to include your beer budget, well, depending on how much beer you drink, that may either be woefully inadequate or far in excess of what you need.

00:36:33.200 | I know a lot of UF students that that wouldn't last them for three months if it were coming out of that.

00:36:38.200 | So you've got to figure out what is your actual budget.

00:36:42.200 | So let's use $20,550.

00:36:44.200 | Next, you need to do a simple, very simple calculation here, and you're going to do a future value calculation based upon how much you think the cost of college is going to rise over the coming years and then how many years it's going to rise.

00:36:58.200 | So we get to our second assumption.

00:37:00.200 | What's the inflation rate of college expenses?

00:37:03.200 | Well, this varies dramatically.

00:37:06.200 | So if I look at a chart here, then I pulled two charts here, and I'll link to the charts that I'm using in the show notes.

00:37:13.200 | But from 1958, according to FinAid, financialaid.org, they say that from 1958 to 2005, the rate of college inflation costs was 6.89%.

00:37:26.200 | 1958 to 2005, 6.89%.

00:37:30.200 | So I've often used in my calculations a 7% inflation rate.

00:37:35.200 | Now, question, is that accurate?

00:37:38.200 | Is that going to continue going forward?

00:37:40.200 | Maybe. I don't know.

00:37:44.200 | That's almost, 1958 to 2005, so that's almost a 50-year calculation.

00:37:52.200 | It's been inflating at 7% for the last 50 years.

00:37:55.200 | Is there any reason why it can or can't or will or won't keep inflating at 7%?

00:38:01.200 | Well, that's where you have to pull out your crystal ball and say, what do you think?

00:38:06.200 | Are there market forces?

00:38:07.200 | Is the cost going to continue going up because the demand is still there, or is the demand falling?

00:38:12.200 | Personally, I don't see how it could increase at that rate with all of the other options and the kind of the lowering of demand and all of the negative publicity that I see.

00:38:22.200 | From 1989 to 2005, the inflation rate was 5.94%.

00:38:26.200 | But for the same period, the general inflation rate from 1989 to 2005 was 2.99%.

00:38:34.200 | So even at 5.94, let's call it 6, and even at 2.99, let's call it 3, then the cost of college tuition was at double the generalized rate of inflation.

00:38:45.200 | Is that sustainable?

00:38:47.200 | I don't know.

00:38:49.200 | Personally, I don't think it is.

00:38:51.200 | And so I would be very surprised if that continued for another 17 years.

00:38:56.200 | But as a planner, this is the trouble that you always get into as a planner.

00:39:01.200 | What do I tell a client?

00:39:02.200 | I have to go based upon facts.

00:39:04.200 | This is what historically the rate of inflation has been, or I have to use the assumptions that the client says.

00:39:10.200 | Well, most clients don't know what the rate of inflation of college has been.

00:39:14.200 | So what number do I use?

00:39:16.200 | I don't know.

00:39:17.200 | But for my calculations today, I'm going to use 6%.

00:39:20.200 | I'm going to go with the 1989 to 2005.

00:39:22.200 | Notice that it's down, by the way, falling 6% except for 1958 to 2005.

00:39:27.200 | I think that my personal prediction is that trend will continue, but I could be wrong.

00:39:31.200 | So now I've got 6%.

00:39:33.200 | So let's use 6%.

00:39:35.200 | So how many years from now will my child go to college?

00:39:38.200 | That's the next calculation.

00:39:39.200 | Well, I have a one-year-old, so I'm going to use 17 years.

00:39:42.200 | If you've got an 11-year-old, then how many years?

00:39:45.200 | You just plug in the number.

00:39:47.200 | And so it's a very simple calculation.

00:39:49.200 | You pull out the financial calculator.

00:39:51.200 | First step, clear your register.

00:39:53.200 | So run a quick clearing function, always a good habit to get into.

00:39:57.200 | Clear the register.

00:39:58.200 | So now we're going to put in $20,550.

00:40:01.200 | That's going to be the tuition payment in the future.

00:40:04.200 | That's what I'm--excuse me, in today's dollars, that's the number that I'm going to inflate

00:40:07.200 | because that's the cost of attendance at UF based upon what the UF chart says.

00:40:10.200 | If you want to assume $10,000, use that number.

00:40:13.200 | If you want to assume $40,000, use that number.

00:40:15.200 | I'm going to use $20,550.

00:40:18.200 | And because this is a cash outflow, you're going to hit a change to the sign,

00:40:22.200 | and then you're going to put that in your present value.

00:40:24.200 | So hit PV on your calculator, present value.

00:40:27.200 | For the number of years, let's do this in years, so I'm going to use 17.

00:40:31.200 | So hit the 17 and then hit N for the number of years.

00:40:35.200 | And then for the interest rate, we're going to use the projected rate of inflation

00:40:39.200 | that we're going to choose for college.

00:40:40.200 | If you're using 6, if you're using 6, 7, or 5, I'm going to use 6.

00:40:44.200 | So I'm going to hit 6 and then I'm going to hit I.

00:40:47.200 | And because we're just doing a very simple future value calculation,

00:40:51.200 | if you're confident, the calculator will just have 0 in it,

00:40:54.200 | but I always like to put 0 in as the payment just in case I forgot to clear the register.

00:40:58.200 | So I hit 0 for the payment because there's not going to be any cash flows in or cash flows out.

00:41:02.200 | We're just doing a simple future value calculation.

00:41:05.200 | And then just hit that button of future value.

00:41:08.200 | And it's going to run and it's going to spit out for me that the future value is $55,336.48.

00:41:16.200 | So what I've calculated is that if my son were to go to the University of Florida,

00:41:20.200 | then the first year of his tuition is going to cost him $55,336.48,

00:41:28.200 | assuming that the rate of inflation goes for college expenses at 6%

00:41:32.200 | and assuming that we want to cover the equivalent cost of what we can buy today

00:41:37.200 | of what they suggest for undergraduate expenses for on or off campus, which is $20,550.

00:41:43.200 | So that's step one.

00:41:45.200 | Now, step two, what you essentially need to do in step two in the second calculation

00:41:49.200 | is you need to determine how much money needs to be available to fund the cost of college

00:41:55.200 | starting at the age of 18.

00:41:58.200 | So the very first thing you're going to do is you need to calculate,

00:42:02.200 | and this is one of those things where if you're not familiar with doing these inflation-adjusted returns,

00:42:07.200 | you're going to get familiar.

00:42:08.200 | You need to do this properly to get this question right on the CFP exam.

00:42:12.200 | So you need to calculate what's the total present value that your child needs at 18

00:42:18.200 | in order to pay for the cost of a college at 18, 19, 20, and 21,

00:42:23.200 | assuming we're doing a four-year plan, which is another assumption.

00:42:27.200 | So here's how you calculate it.

00:42:29.200 | I would recommend that you start by calculating your inflation-adjusted return.

00:42:33.200 | So you need to figure out next what is the rate of return that I'm going to plan on from my investments

00:42:39.200 | and then what is the rate of return, what's the cost, the rate of inflation that I'm planning on for the college costs.

00:42:46.200 | So what rate of return should we use for our investments?

00:42:50.200 | Hard question to answer, right?

00:42:52.200 | Depends on what you're invested in.

00:42:54.200 | Depends on what the asset allocation of your portfolio is.

00:42:57.200 | Depends on where we are in an economic cycle.

00:43:00.200 | Depends on the stability of your portfolio at that point in time.

00:43:04.200 | Are you going to pull out the -- we always talk about a five-year time horizon for volatile investments,

00:43:11.200 | such as publicly traded stocks.

00:43:13.200 | Perhaps some parents will say, "We're going to pull it all out and put it in cash at the age of 18."

00:43:18.200 | Well, in that scenario, then our rate of return is going to be, what, 1% maybe from 18 to 22?

00:43:24.200 | Or are you going to plan on 8% per year from 18 to 22?

00:43:28.200 | Do you have an investment portfolio that can deliver that,

00:43:30.200 | and do you have a strategy for pulling money off of that that's going to follow those assumptions for you?

00:43:35.200 | So that's kind of hard to answer, but for my purposes, I'm just going to use -- I'm going to plug in 8%.

00:43:42.200 | So let's pretend that we're going to get an 8% return net of fees and net of tax.

00:43:47.200 | So we can avoid the tax with a college account, maybe a 529 account, something like that,

00:43:51.200 | and the fees are going to vary depending on the fees on your investment portfolio.

00:43:54.200 | But let's use an 8% return.

00:43:56.200 | So we need to do an inflation-adjusted return.

00:43:59.200 | Always, to get mathematically the right answer.

00:44:02.200 | So to do an inflation-adjusted return, you're going to use 1 plus the rate of return of investments

00:44:09.200 | divided by 1 plus the rate of inflation minus 1 times 100.

00:44:15.200 | You're going to have to memorize that formula.

00:44:17.200 | So in this example, 8% rate of return, 6% rate of inflation, 1.08 divided by 1.06,

00:44:24.200 | then subtract 1, minus 1, and then multiply that times 100.

00:44:30.200 | And that gives you, in my example, 1.89%.

00:44:33.200 | Now depending on how many decimal places you need, if you ran this at 4 decimal places, it would be 1.8868.

00:44:40.200 | For today's show, I'm going to run this at 2 decimal places.

00:44:43.200 | For the CFP exam, you might want to run it at 4.

00:44:47.200 | That's what I used to do, but it just depends.

00:44:50.200 | Probably it's not going to matter, but I would run mine at 4.

00:44:54.200 | I used to do that, run it at 4, just in case.

00:44:56.200 | So 1.89% is our inflation-adjusted rate of return.

00:45:00.200 | This is the mathematically correct way to do it.

00:45:02.200 | You'll notice, just to check this, this is basically close to 8 minus 6,

00:45:06.200 | but this is the mathematically accurate way.

00:45:08.200 | So that's the rate of return that we're going to use on our portfolio in the next step.

00:45:11.200 | So now what we're going to do is, again, we're calculating what's the present value that we need

00:45:15.200 | at the age of 18 to fund this cash flow need from 18 for the next 4 years to 2022, '21, '22.

00:45:23.200 | So let's put in the calculation from step 1.

00:45:26.200 | So we calculated that the future value that we need is $55,336.48.

00:45:32.200 | So let's clear the register, and I'll just do it manually,

00:45:35.200 | although once you're comfortable with this, you could just simply take that answer and plug it in as for the payments.

00:45:41.200 | So we're going to put that number in as a payment, $55,336.48,

00:45:47.200 | and we're going to put that in as a payment.

00:45:49.200 | Now the N is going to equal 4, because that's going to be for 4 years.

00:45:53.200 | The number of periods is 4.

00:45:55.200 | 1.89 goes in for the I, because that's the annualized of inflation-adjusted return.

00:46:01.200 | And we're going to put in 0 for the future value,

00:46:03.200 | because at the end of the 4 years, we want to be left with $0.

00:46:06.200 | And then we're going to solve for the present value.

00:46:10.200 | Now it's important that you remember to put your calculator into the beginning mode.

00:46:15.200 | So when you're doing your calculations for the CFP exam, the question is,

00:46:18.200 | are you doing an after--at the end of a period calculation or at the beginning of a period calculation?

00:46:23.200 | And you need to get that right.

00:46:25.200 | So for college costs, it's going to be at the beginning of the period,

00:46:29.200 | because tuition is due before the year begins.

00:46:34.200 | In general, you're going to use the beginning mode for college tuition payments,

00:46:40.200 | retirement benefits, and then family needs,

00:46:43.200 | because if you're ever asked for that, you need cash flow before the event.

00:46:48.200 | So that's when you're going to use the beginning mode.

00:46:50.200 | You're going to use the ending mode on your financial calculator

00:46:53.200 | when you're doing 401(k) deferrals,

00:46:55.200 | because those contributions are going to come at the end of the period,

00:46:58.200 | profit-sharing contributions, because that's going to come at the end of the period,

00:47:02.200 | and bond interest calculations, because the bond interest is paid after the period,

00:47:06.200 | and mortgage payments.

00:47:07.200 | So that's when you're going to use your end mode.

00:47:10.200 | You need to be careful with that, because you may get--

00:47:13.200 | especially if the question is written in a persnickety manner--

00:47:15.200 | you may get that wrong, and that's just a simple thing that you need to get right.

00:47:20.200 | So now you just run the calculations.

00:47:22.200 | I'm going to redo it here-- 55,336.48 for my payments,

00:47:33.200 | and then N is 4, 1.89 is the I, 0 is the future value,

00:47:39.200 | and the present value is now going to be $215,262.97.

00:47:45.200 | That's what I need.

00:47:47.200 | If I put the payment as a positive, then the present value is going to be a negative,

00:47:50.200 | because it's going to be a cash outflow.

00:47:52.200 | So I need a present value in the first year of college of $215,262.97.

00:47:58.200 | That's my target.

00:47:59.200 | Step two.

00:48:01.200 | Now, final step of the calculation is just calculate how much you need

00:48:04.200 | to hit that present value number, to hit the $215,262,

00:48:09.200 | based upon the number of periods that you have.

00:48:12.200 | So this is where you can figure it out very easily.

00:48:14.200 | So if you want to do it precisely, you could clear the register.

00:48:18.200 | I would usually just stick it over and flip it from the present value to the future value.

00:48:24.200 | But let's do it manually.

00:48:25.200 | Clear the register--$215,262.97.

00:48:29.200 | That's what we need is the future value.

00:48:32.200 | Then plug in the number of years for step three,

00:48:34.200 | the number of years until we need that number.

00:48:36.200 | So I'm going to use 17.

00:48:38.200 | Now you're going to put in your investment rate of return.

00:48:41.200 | Now here, we're going to use whatever the return is that you think you're going to get

00:48:44.200 | on your investment portfolio.

00:48:47.200 | So I'm going to use 8%.

00:48:49.200 | We've already calculated the inflation-adjusted return during those college years.

00:48:53.200 | So now if we just get this number right, we get this future value at the age of 18,

00:48:57.200 | then we don't need to worry about the inflation-adjusted

00:49:00.200 | because that's already an inflation-adjusted number.

00:49:02.200 | So let's just put in 8% for interest, 8, and hit that for interest.

00:49:07.200 | And now you can, depending on whether you want to solve for a lump sum

00:49:12.200 | or whether you're going to solve for a lump sum that you need today

00:49:16.200 | or whether you're going to solve for a series of payments,

00:49:18.200 | and you need monthly payments or annual payments,

00:49:20.200 | now you can easily solve that information.

00:49:23.200 | And so then also you need to, with this step, when you're looking on the exam,

00:49:28.200 | you're going to read the exam to see what do they want.

00:49:30.200 | Do they want an annual number, a monthly number, or a lump sum number?

00:49:33.200 | You also need to figure out whether or not you're going to use beginning or end mode

00:49:37.200 | based upon how the question is asked with the cash flows.

00:49:42.200 | So I'm just going to leave my calculator in beginning mode,

00:49:45.200 | and I'm going to hit the present value number,

00:49:47.200 | and that's going to give me the lump sum today.

00:49:49.200 | So if I wanted to save for that $215,000 expense when my son is 18 years old,

00:49:55.200 | all I need today is a lump sum of $58,000.

00:49:58.200 | And if I can hit the lump sum of $58,000, then I'll be on track of where I need to be.

00:50:07.200 | Then it's easy just to test it.

00:50:09.200 | So flip that and put that number back in for your present value.

00:50:14.200 | Put in zero for your payments.

00:50:16.200 | Make sure you still have 17 for your N, 8% for your I,

00:50:20.200 | and then solve for your future value and see if you wind up with $215,000 in the account.

00:50:24.200 | So it's easy to test yourself, always easy to check yourself on the situation.

00:50:28.200 | If you wanted to know how much do I need to save each year,

00:50:32.200 | well, what I'll just do is let's use that $215,000 number as the future value.

00:50:37.200 | I'm just going to double-check myself.

00:50:39.200 | So 17 is the I, 8 is the N, put in zero for the present value, and solve for the payment.

00:50:44.200 | So this is going to equal the annual payment.

00:50:46.200 | Now I know what I need to save, $5,905 per year if I wanted to do that.

00:50:52.200 | If I wanted to know per month what I needed to solve,

00:50:55.200 | then what I'll do is I'll just flip this to monthly calculations.

00:50:58.200 | So I'll put 17, and then I'm using an HP 12C,

00:51:01.200 | so I'm going to hit the blue button and hit the 12X button.

00:51:05.200 | That multiplies 17X12 to give me the monthly number of periods, which is 204.

00:51:10.200 | Then I take 8, 8, hit the blue button, hit the I.

00:51:13.200 | That gives me, instead of an 8% annual return, I get a 0.67% monthly return.

00:51:18.200 | I'm going to keep it at zero for the PV.

00:51:21.200 | I've still got the same future value in the calculator.

00:51:24.200 | I'm just going to hit the payment, and now that gives me I need $495.23 per month.

00:51:29.200 | So now I know if I wanted to save for my child's education,

00:51:32.200 | under those assumptions, I need $495.23 per month.

00:51:36.200 | This is easy once you have these steps here.

00:51:39.200 | It's easy to do all kinds of scenarios.

00:51:41.200 | Let's say I'm starting with a $10,000 present value

00:51:45.200 | because I have $10,000 from my kid's grandparents.

00:51:48.200 | Now I'm going to solve for the payment.

00:51:50.200 | Now I just need--I put the math in wrong. Hang on. I've got to flip the sign.

00:51:55.200 | Now I just need $406 per month.

00:51:58.200 | The mistake I made, I had flipped the--making the--

00:52:03.200 | you have to keep your future value and your payments opposite signs.

00:52:07.200 | So I put them in as the same sign, and it was showing more

00:52:09.200 | because I added an extra $10,000 cash flow.

00:52:12.200 | So if I have $10,000 today and I have 17 years, I just need to save $406 a month.

00:52:16.200 | So it's fairly easy to do these calculations once you know those three steps,

00:52:20.200 | and we're done with the math.

00:52:22.200 | Memorize those three steps, practice them,

00:52:24.200 | and once you have them memorized and practiced, then you'll be in good shape,

00:52:27.200 | and you can work with those three steps, and you can do these calculations easily.

00:52:32.200 | Now here's the problem.

00:52:34.200 | That's the math, and that's what all software is going to do.

00:52:37.200 | But how valid is that math?

00:52:40.200 | Well, it's only as valid as the assumptions, right?

00:52:44.200 | So now that you've seen the math, you can now--

00:52:46.200 | should be able to go through and identify all the assumptions.

00:52:49.200 | So how much does college cost?

00:52:51.200 | Well, that depends on where you're going to go to school.

00:52:53.200 | Are you going to go to school at a state school, at a private school?

00:52:57.200 | Are you going to go to school in Florida, in New York City,

00:53:00.200 | or are you going to go in Mississippi or in Alaska?

00:53:04.200 | What is the cost of living going to be?

00:53:06.200 | Are we going to pay for tuition?

00:53:07.200 | Books--are textbooks still going to be the ripoff racket that they are today,

00:53:11.200 | or are they all going to be digital and we pay $5 and print a PDF off?

00:53:14.200 | What is it actually going to be?

00:53:16.200 | So what is college actually going to cost?

00:53:18.200 | Well, how many years are we going to go to college?

00:53:20.200 | Is it going to be three years or is it going to be five years?

00:53:23.200 | You can do a four-year degree in three years--my wife did that--

00:53:26.200 | or you can do it in six or seven years.

00:53:28.200 | I have a sibling who did that.

00:53:31.200 | So how many years are you going to do that?

00:53:34.200 | Are you going to be on campus or off?

00:53:36.200 | Are you going to pay for the cost of housing or not?

00:53:38.200 | Is it going to be an expensive housing or cheap housing?

00:53:41.200 | What about other cash flows that the student's going to receive?

00:53:43.200 | Are they going to receive scholarships?

00:53:45.200 | Are they going to receive financial aid?

00:53:46.200 | Some schools are very expensive but have excellent financial aid programs

00:53:49.200 | based upon the previous graduate to the school.

00:53:52.200 | Is the student going to be working and contributing?

00:53:55.200 | What's the inflation rate going to be?

00:53:57.200 | Is there going to be an entirely new college system invented over the next 10 years

00:54:02.200 | that's based upon proof of results, not proof of class attendance and test-taking?

00:54:10.200 | Then what about your actual investment portfolio?

00:54:13.200 | What's your actual rate of return?

00:54:15.200 | This is tough to predict in the short term.

00:54:17.200 | If you have a 15-year-old and you are investing for this 15-year-old to go to school at 18,

00:54:25.200 | are you really going to feel comfortable with a volatile stock portfolio?

00:54:30.200 | What if you did this in 2004 and then all of a sudden in 2007 and 2008

00:54:35.200 | you find yourself needing to pull money off for that kid's college?

00:54:38.200 | This happened to a lot of parents.

00:54:40.200 | Is your portfolio protected from that?

00:54:42.200 | Well, if you're going to adjust your portfolio as time goes on--

00:54:45.200 | so let's say you're going to start in the beginning,

00:54:47.200 | "I have a one-year-old son, I'm investing aggressively for him,

00:54:49.200 | then I get concerned as he gets closer to the need for the cash flow,

00:54:52.200 | and I go ahead and start adjusting for that,"

00:54:56.200 | then is that going to affect my rate of return?

00:54:58.200 | If I factor that in, am I going to go from an 8% rate of return

00:55:01.200 | to a 3.5% rate of return?

00:55:03.200 | It's really tough to predict in the short term.

00:55:05.200 | How are you going to handle the distributions from the account,

00:55:07.200 | the rebalancing of the account?

00:55:09.200 | Is that inflation-adjusted return calculation during those four years of college

00:55:14.200 | actually valid?

00:55:16.200 | Because as you start to deplete your $215,000 account,

00:55:19.200 | you're actually still earning 8% in that third year

00:55:22.200 | right before you get it in that fourth year.

00:55:24.200 | That's what the math is, and that's what you need to know to pass the CFP exam.

00:55:27.200 | But now you've got to bring that into the real world and say,

00:55:29.200 | "Well, wait a second. Is this actually valid?"

00:55:33.200 | What are your fees? What are your taxes?

00:55:35.200 | Are you using a tax-free account or using a non-tax-free account?

00:55:38.200 | Are you paying dividend tax?

00:55:40.200 | What are your taxes?

00:55:42.200 | What does the portfolio do?

00:55:43.200 | And then how much do you have now?

00:55:44.200 | Are you saving monthly? Are you saving annually?

00:55:47.200 | Is there going to be some slight benefit because of dollar-cost averaging?

00:55:51.200 | Or did you just inherit a lump sum and you're just going to set aside a lump sum?

00:55:54.200 | When do you need the payments?

00:55:55.200 | How is it going to work?

00:55:57.200 | Here's the problem.

00:55:58.200 | College is almost a perfect illustration of how precise you can be

00:56:04.200 | and how precisely wrong the precise math can be.

00:56:08.200 | Because I can give you--you say, "Joshua, I want a college number."

00:56:11.200 | How much do I need for college?

00:56:14.200 | Well, I can calculate that.

00:56:18.200 | But if you don't understand the assumptions that are in that,

00:56:21.200 | then that number could be perfectly right or it could be woefully wrong.

00:56:25.200 | And that's financial planning.

00:56:27.200 | That's the art and science of financial planning.

00:56:30.200 | And so you can see why when I look at this--

00:56:33.200 | and you can see different scenarios that people would do out of this.

00:56:36.200 | But this is why when I look at the financial world, I think to myself,

00:56:39.200 | "How on earth can an average person without a good knowledge of working finance math--

00:56:44.200 | how on earth can an average person negotiate this in an intelligent way?"

00:56:48.200 | And usually what happens is that most people don't.

00:56:51.200 | Most people either just simply make a choice and they say,

00:56:53.200 | "This is what I'm going to do," without considering all the options.

00:56:56.200 | And then often they make the choice that makes sense to them, which is okay.

00:57:00.200 | We can't sit around and try for the rest of our life to come up with the perfect solution.

00:57:04.200 | But sometimes you make the choice that is okay

00:57:07.200 | and then we feel confident because we made it and we get confirmation bias.

00:57:11.200 | And we don't know everything else that was there.

00:57:13.200 | And so then we tell everyone else, "Here's what you should do.

00:57:15.200 | Here's what you should do. Here's what you should do."

00:57:17.200 | This happens most of the time with 529 plans.

00:57:19.200 | So many people, because of all the uncertainty over running an investment portfolio

00:57:23.200 | and how are we going to do this,

00:57:25.200 | then people are attracted to the direction of prepaid tuition programs.

00:57:30.200 | And prepaid tuition programs are great because they take out some of the uncertainty.

00:57:34.200 | But in exchange for the uncertainty, they wind up with a lower rate of return

00:57:39.200 | than what is possible in the other scenario.

00:57:42.200 | Now, should you do a prepaid tuition program or should you save and invest?

00:57:46.200 | Obviously, it depends. It depends on your situation.

00:57:49.200 | It depends on what you're doing. It depends on all the options.

00:57:51.200 | So I hope this gives you a good introduction to the math.

00:57:56.200 | We're going to talk through in the future all the fun ways and the fun accounts

00:58:01.200 | and kind of how they work.

00:58:03.200 | And you can see how with this foundation, though, you could start to look at certain things.

00:58:08.200 | And then you can start to figure out, "Well, what is my actual savings going to be?"

00:58:11.200 | I'll give you one little pet peeve of mine.

00:58:13.200 | If you have a 12-year-old child and you're going to save $150 a month for that 12-year-old child,

00:58:20.200 | please do not start a 529 plan and think that the tax savings matters a bit.

00:58:25.200 | It doesn't.

00:58:26.200 | Don't put yourself and lock yourself up under the bondage of a college account

00:58:30.200 | for 33 cents of tax planning.

00:58:33.200 | It's not going to matter and you're probably not in a tax rate if you're saving $150 a month

00:58:38.200 | where it's at all relevant.

00:58:40.200 | I'll tell you who I love 529 plans for.

00:58:42.200 | I love 529 plans for rich parents and rich grandparents who are doing estate planning

00:58:48.200 | and they have lots of money and they want to fund kids' college accounts

00:58:51.200 | and they want to be able to have a string on the money but get it out of their estate.

00:58:54.200 | The 529 plan is actually the only account that I'm aware of that's useful for estate planning

00:59:00.200 | that allows the donor to get the money out of their estate but still to have control over the account.

00:59:06.200 | This is phenomenal.

00:59:08.200 | This is awesome.

00:59:09.200 | The majority of estate planning--

00:59:11.200 | The essence of estate tax planning, if we're trying to avoid estate taxes,

00:59:17.200 | is that we want to transfer money before the death of the donor.

00:59:22.200 | So that at their death, their estate is not taxed for the money.

00:59:28.200 | A 529 plan is an awesome way to do that

00:59:31.200 | because what you can do is the donor, the grandparent,

00:59:35.200 | can front load five years worth of contributions to the account.

00:59:41.200 | And that's five years of the annual exclusion.

00:59:45.200 | So right now, the annual exclusion is $14,000 times five.

00:59:48.200 | So that means that a grandfather can put aside $70,000 into an account for a grandchild.

00:59:55.200 | And then the grandmother can put aside $70,000 into an account in a 529 account.

01:00:00.200 | That's $140,000.

01:00:03.200 | $140,000. Boom.

01:00:06.200 | And they can do that per child.

01:00:09.200 | That can actually be done from--

01:00:11.200 | The parents can do that too.

01:00:13.200 | So the parent can do $140--

01:00:15.200 | Mom and dad each can do $70,000.

01:00:17.200 | That's a prepaid gift for five years.

01:00:19.200 | You can basically, again, front load five years.

01:00:21.200 | So they can put--

01:00:22.200 | Let's just stick with the grandparents in this example.

01:00:24.200 | $140,000 into this 529 account.

01:00:27.200 | Boom. That money is outside of their estate.

01:00:29.200 | They don't have to worry about it.

01:00:31.200 | That $140,000 is front loaded, and this can be done at the age of zero.

01:00:35.200 | So once the baby is there, it can be done at the age of zero.

01:00:38.200 | Now that account is front loaded.

01:00:40.200 | That's $70,000.

01:00:42.200 | Let's calculate real quick.

01:00:43.200 | Let's do $140,000.

01:00:45.200 | Let's just run that as--

01:00:48.200 | For this 18 years, and let's just use an 8%.

01:00:52.200 | Let's put no further payments, and let's do future value.

01:00:56.200 | Okay. So $140,000 into this account.

01:00:59.200 | They can do that at age zero, and 18 years later,

01:01:03.200 | at an 8% rate of return, that account is worth $559,000.

01:01:07.200 | We'll call it $560,000.

01:01:09.200 | Remember, they put $140,000 into that account.

01:01:12.200 | And so now you're in a situation where there's $420,000 of gain

01:01:17.200 | sitting in the account, where because it's a college account,

01:01:20.200 | that gain is not taxable when it's pooled out for the purposes of college expenses.

01:01:25.200 | Now in this scenario, remember the cool thing about the 529 account

01:01:32.200 | is that the account owner can change the beneficiary of the account at any time,

01:01:37.200 | as long as the new beneficiary is a family member of the original beneficiary.

01:01:42.200 | And a family member includes a lot of people. That's parents, step parents, grandparents, children,

01:01:47.200 | step child, sibling, step brother, step sister, niece, nephew, aunt, uncle, brother in law

01:01:54.200 | sister in law, daughter in law, son in law, father in law, mother in law, first cousin, or spouse.

01:02:01.200 | So all of a sudden now, there's $560,000 sitting in an account with $420,000 of gain

01:02:12.200 | that is outside of the grandparent's estate.

01:02:15.200 | That the grandparent, however, uniquely, can still continue to adjust,

01:02:20.200 | can still continue to change the beneficiary.

01:02:24.200 | So if they need to adjust it from a child to a sibling to another child to a first cousin or whatever.

01:02:29.200 | That's the only estate planning technique that some of you need.

01:02:32.200 | Boom, right there. With that plus the fairly generous standard exemptions,

01:02:40.200 | with the fairly generous there, you don't need much more than that.

01:02:43.200 | So in that scenario, 529, no trust documents, although there's no reason why,

01:02:49.200 | there's nothing in the tax law that prevents a 529 plan from being owned by a trust,

01:02:55.200 | but there are some disadvantages to it, but skip that for now.

01:02:57.200 | No trust documents, no trustee, it's just a 529 account.

01:03:00.200 | And you can change the beneficiaries at any time.

01:03:03.200 | And you can change it to any of those people.

01:03:05.200 | Isn't that cool?

01:03:07.200 | So you have this one account, and I maintain that the vast majority of 529 college savings accounts

01:03:14.200 | are an utter waste of time as far as the actual savings versus the restrictions.

01:03:19.200 | And I would far rather just not have it at all.

01:03:23.200 | But yet that doesn't mean it's a bad account,

01:03:25.200 | it just means you've got to put it in its right place.

01:03:27.200 | If you can front load these things, if you can pre-fund them,

01:03:30.200 | and if you can actually put money in up front,

01:03:33.200 | then you can really get some major benefits from funding them.

01:03:38.200 | But if you have a 12-year-old, and let's do this, let's run another calculation.

01:03:42.200 | So six years, let's use the same 8% interest, and let's put in zero for the present value.

01:03:49.200 | So you're starting with a 12-year-old child and going from 12 to the year of 18.

01:03:53.200 | And so let's say that you're going to fund this, let's use $100 a month, and I'll just do this annually.

01:03:58.200 | So $1,200 of payment.

01:04:00.200 | After six years, guess what?

01:04:02.200 | Your $1,200 payment per year has grown to be $9,507.36.

01:04:08.200 | Now, 1,200 times 6, that would be $7,200.

01:04:15.200 | Now we pull out $7,200, and we're left with $2,307 of gain.

01:04:23.200 | So tell me this.

01:04:24.200 | You started with a 12-year-old, and you're putting $100 a month into this 529 account.

01:04:29.200 | Now that's allowed you to avoid the tax on $2,300 of gain,

01:04:34.200 | if you're getting that rate of return over that short period of time.

01:04:37.200 | And you're going to take out that $2,300 of gain.

01:04:40.200 | Now this doesn't matter for the math.

01:04:41.200 | Over a period of a few years, maybe.

01:04:43.200 | So what? Are we going to do a 20% tax rate?

01:04:45.200 | So that's going to save you $461 of tax.

01:04:49.200 | Is it worth it to you to do all the hassle of that account to save the $461 of tax?

01:04:54.200 | It might be.

01:04:56.200 | And if you're really good with your planning, maybe that matters,

01:04:59.200 | and that allows you to pay zero taxes.

01:05:01.200 | But comparatively speaking, it's very, very different.

01:05:05.200 | So I hope that's useful to some of you.

01:05:09.200 | I know I didn't get into a lot of the accounts today,

01:05:14.200 | but this is where you start is calculate what the number is.

01:05:16.200 | And I hope this is helpful to help you start to think through some of the assumptions.

01:05:21.200 | That's it for today's show.

01:05:22.200 | I hope you've enjoyed this.

01:05:24.200 | Please mention and notify people.

01:05:27.200 | I hate to lose 1,500 to 1,800 of you guys because I messed up the iTunes stuff.

01:05:32.200 | I'm a rookie at techno stuff.

01:05:34.200 | So please remember to subscribe and unsubscribe in iTunes.

01:05:38.200 | I'd like to support the show if this information has been valuable for you.

01:05:40.200 | I've launched a brand new--on today's episode I launched a brand new membership program.

01:05:44.200 | And this show I intended to be entirely focused on member support.

01:05:50.200 | So consider joining the Irregulars, which is the membership support program that I've established.

01:05:54.200 | It's entirely voluntary, but that is my primary way for paying my bills

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01:06:04.200 | If this has been helpful for you, I would love to have you as a supporting member.

01:06:07.200 | That would make a world--that would really encourage me.

01:06:10.200 | I think I've had--let's see, since last night I've had four or five people, which is super exciting.

01:06:14.200 | It's super exciting.

01:06:16.200 | So check that out.

01:06:17.200 | Go to RadicalPersonalFinance.com/membership, and that will have some info.

01:06:21.200 | Right now I don't have a ton of benefits in the member program, but I'm going to bring a ton over time.

01:06:26.200 | Extra benefits.

01:06:27.200 | Everything is going to be based on the membership program.

01:06:29.200 | And I'm going to bring you guys a ton of e-books, a ton of discount programs

01:06:33.200 | as I can figure those out and negotiate them.

01:06:35.200 | I'm going to bring extra content.

01:06:36.200 | I promise you that it will pay off for you.

01:06:39.200 | If you are not getting at least a 10 times rate of return on the value of your membership,

01:06:44.200 | if for every $10 that you send me--that's what it's priced at is $10 a month--

01:06:48.200 | for every $10 that you send me, if you're not getting at least $100 a month worth of value,

01:06:53.200 | fire me and cancel your membership.

01:06:55.200 | That's my promise.

01:06:57.200 | Do it.

01:06:58.200 | Send me an email and say, "Joshua."

01:06:59.200 | Send me an asked email and say, "Joshua, I only got 6.7 times the value of my membership."

01:07:05.200 | I didn't get 10 times.

01:07:07.200 | So to me, that's what I want to provide for you is 10 times in excess of the cost and the value.

01:07:13.200 | So thank you so much for listening.

01:07:15.200 | I'll be back tomorrow.

01:07:16.200 | I'm playing an interview for you with James Wesley Rawls.

01:07:18.200 | It's going to be fun.

01:07:19.200 | We're going to talk about survivalism as financial planning.

01:07:21.200 | He's the editor of survivalblog.com.

01:07:24.200 | He's an awesome guy.

01:07:25.200 | And I know a lot of you guys have questions on that topic, and it's really fun.

01:07:29.200 | I love to find these little threads that I can use to apply to financial planning.

01:07:33.200 | So this is probably the only show in the world where on day one you'll hear someone talk about 529 accounts and their value,

01:07:39.200 | and then the next day with survivalism.

01:07:41.200 | So thanks for being here.

01:07:42.200 | Come back tomorrow.

01:07:43.200 | Thank you for listening to today's show.

01:07:45.200 | This show is intended to provide entertainment, education, and financial enlightenment.

01:07:53.200 | Your situation is unique, and I cannot deliver any actionable advice without knowing anything about you.

01:08:01.200 | This show is not and is not intended to be any form of financial advice.

01:08:08.200 | Please, develop a team of professional advisors who you find to be caring, competent, and trustworthy,

01:08:18.200 | and consult them because they are the ones who can understand your specific needs,

01:08:24.200 | your specific goals, and provide specific answers to your questions.

01:08:30.200 | Hold them accountable for your results.

01:08:33.200 | I've done my absolute best to be clear and accurate in today's show, but I'm one person and I make mistakes.

01:08:39.200 | If you spot a mistake in something I've said, please come by the show page and comment so we can all learn together.

01:08:46.200 | Until tomorrow, thanks for being here.

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