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Friday, August 05, 2005

College Funding Math - Part I

Today, I'm going to show you how to calculate how much you should be saving to meet future college expenses. It isn't that hard to do, but it will require some mathematical formulas that border on the complex. But, don't worry, I'll walk you through it so you aren't alone! So, here we go:

Assumptions: Hector (I figured we might as well have some fun with the name) is 5 years old and will start college when he is 18, which is 13 years away. You currently have $3,000 in Hector's college fund. One year at a public university currently costs $13,000 and we will assume that the college inflation rate is 5.0% (or .o5) per year. We will also assume that Hector will be in college for 4 years. We will assume the growth rate on the investment account is 8% (or .o8). Finally, we will assume that the annual amount saved will cease once Hector starts college.

Step One - Calculate the future expected cost of four years of college

This is a simple time-value of money calcuation, using the following equation:

Future Cost = Current Cost X (1 + Inflation Rate)N

Don't let the formula scare you. We will plug in the numbers that we know:

Current Cost = $13,000
Inflation Rate = 5.0% or .05
N = Number of Years Away which is 13

So, after plugging in the appropriate numbers, the formula looks like this:

Future Cost = $13,000 X (1 + .05)13

We perform the following steps to solve for the Future Cost:

Future Cost = $13,000 X (1.05)13

Future Cost = $13,000 X 1.8856491

Future Cost = $24,513

So, we now know that in 13 years, the first year of college will cost $24,513. Since this is the amount for only for the FIRST year, we must run the calculation 3 more times, using the same formula as above but changing "N" to reflect the appropriate number of years away. NOTE: since the first year of college is 13 years away, the second year would be 14 years away, the third would be 15 years away and the fourth would be 16 years away.

After you run the formula for each year, you should come up with this:

Year 1 = $24,513
Year 2 = $25,739
Year 3 = $27,026
Year 4 = $28,377
TOTAL = $105,655

We now know that at a 5.0% inflation rate four years of college for Hector is going to cost $105,655. The next step is figure out how much you need to be saving to meet this goal. That will be the subject of the next post.

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