Saving for College: Can Debt Beat Your Kid's 529?

iDd looks at college debt that, when paired with an investment account, potentially beats the 529 college savings plan by a wide margin. 

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Chapters

• 1:26 Opportunity Cost
• 2:29 Key Assumptions
• 2:58 How it Works
• 4:23 Results
• 4:55 Downsides
• 6:45 Post College Scenario
• 8:55 Action Steps
• 10:38 The Big Picture

Transcript

Hey, everyone, and welcome back for another deep dive.
Today, we're gonna be tackling a topic
that I'm sure is on a lot of minds these days,
figuring out how to pay for college.
Yeah.
And, you know, you've probably heard
the advice a million times, start saving early,
open a 529 plan, every dollar helps.
Right.
Well, what if I told you there might be a bolder way,
a potentially even more lucrative path?
See, now you've got my attention.
Right.
I mean, I've heard it all when it comes to college financing,
but this is new.
So what are we talking about here?
Well, that's what we're diving into today.
This academic paper we've got, higher education,
can debt beat savings.
It's a, it's really challenging conventional wisdom
when it comes to this stuff.
It is.
I mean, you know, before we even get into the specifics,
I think what's so fascinating about this paper
is just how directly it challenges
that conventional wisdom that you're talking about.
Yeah.
Are they seriously suggesting ditching the $5.29 plan
that's supposed holy grail of college savings
and instead strategically taking on debt?
Could that actually lead to greater wealth?
Really?
That is exactly what they're saying.
Wow.
And I'll admit, when I first read this,
I was pretty skeptical too, you know?
But before anyone listening,
throws their headphones out the window.
Right.
We need to understand their reasoning here.
It all boils down to this concept of opportunity cost.
Okay, break that down for me a little bit.
What is opportunity cost in this context?
So think about it this way.
Every dollar that you put into that $5.29 plan,
while it is growing tax-free,
it's a dollar that is not experiencing
potentially greater growth out in the market.
I see.
Over a much longer period of time.
So it's like the difference between taking, say,
a guaranteed small return
or maybe taking a little bit of a calculated risk
for what could be a much bigger payoff on a road.
Exactly.
It's like recognizing that the money that you invest
in your 20s that has decades,
decades more time to grow than the money you save,
even if it's a larger amount in your 40s.
This paper is arguing that the lifespan of your money
where you put it and for how long can actually matter more
than those upfront tax advantages.
Interesting.
The $5.29 plan.
Okay, I think I'm starting to get the gist of this,
but paint a picture for me here.
What are we actually talking about numbers wise?
What does this look like in the real world?
All right, so to illustrate this,
the authors use a model
and it's based on some key assumptions.
They assume an $80,000 cost for a four-year public university,
a student loan interest rate will say average of 5.8%.
A 10-year loan repayment period,
again, we're talking averages here,
and an average annual return on investments of 8.6%,
adjusted for 3% inflation.
Okay.
So those are some fairly reasonable starting points
for a lot of families out there.
Yeah, absolutely.
Let's walk through how this debt alternative account scenario
as they call it actually works in practice.
Let's do it.
So imagine this.
Instead of putting all that money into a $5.29 plan,
you take out student loans in this case,
the full $80,000 to cover the cost of college.
But at the same time,
you're also opening a separate investment account.
And you are contributing the exact same amount
that you would have been putting toward that $5.29.
Interesting.
So you're essentially treating that money
as investment capital to be grown
over a much longer time frame
than just those few years leading up to college.
Yes, you've got it.
They're essentially saying, take on the debt,
but don't let that scare you into playing it safe
with the rest of your finances,
invest aggressively instead.
Wow.
Okay, so where does it go from there?
Well, and this is where it gets really interesting.
The paper really emphasizes that this separate account
that you're creating,
this benefits significantly from what's known as
the time as the greatest asset principle of investing.
Okay, and that means...
Basically, it means that even with the normal ups
and downs of the market that we all know,
having that money invested for such a long period of time,
even if you're making smaller contributions earlier on,
right?
This can lead to much greater returns down the line.
It's like that snowball effect.
Yeah.
The earlier you start,
the more time it has to potentially grow and compound,
and you end up with something much bigger in the end.
Yes.
And to really drive this point home,
the paper's calculations actually show that by retirement,
this strategy, this debt's alternative account strategy,
could potentially grow to nearly a million dollars
adjusted for inflation.
A million dollars.
A million versus maybe a couple hundred thousand
with the 529 if you're lucky.
Wow, that's a massive difference.
Right.
But I'm sure there's some people listening right now
who are saying, okay, but what about the risk?
Right, because we're not living in a vacuum.
We have to consider the downsides, the what ifs.
What if interest rates decide to go crazy?
Or the market tanks?
Right, right.
Does this whole thing, does it all just fall apart
if things get a little rocky?
Yeah.
So let's delve into that.
Let's talk about some of those counterarguments
and see how sturdy this strategy really is.
So let's talk about those what ifs.
What if interest rates decide to go through the roof?
Yeah.
Or the market takes a nose dive
right when someone's about to graduate?
Does this debt alternative account thing,
does it still work then?
Well, that's the million dollar question, isn't it?
Literally.
But thankfully, this paper doesn't shy away
from those real world's concerns.
They actually ran simulations
using all kinds of less than ideal conditions.
Higher interest rates on student loans,
lower average returns on investments,
even looked at longer repayment periods.
You know, things happen, life gets in the way,
and they wanted to see how those factors
would impact the outcome.
So what did they find?
Did this whole strategy just crumble under pressure?
It's not a total disaster movie, thankfully.
Yeah.
Well, yes, the overall returns were understandably smaller
in those gloonier scenarios.
Here's the really interesting thing.
In a lot of cases, that alternative approach
that debt and separate invest route,
it still ended up with someone having significantly more money
by retirement than if they just stuck
with the traditional 529 plan.
Wow.
Yeah, it's pretty wild.
So, okay, so it's not like this magical risk-free guarantee.
Right.
But it seems like it can withstand some bumps in the road.
I bet there are some people listening right now
who are thinking, okay, but what about
just old-fashioned discipline?
What if instead of taking on all that debt,
I just buckle down after I graduate,
and I invest the equivalent of those loan payments?
Yeah.
Maybe even supercharge it with money from a 529
or something, wouldn't that be just as good
or maybe even better in the long run?
You're hitting on what the authors of this paper
call the post-college account scenario,
which is a very valid question.
I mean, there's something very appealing
about that delayed gratification idea, right?
Right.
And at least in the short term, it does look promising.
What they found was that, yes,
if you consistently invest those loan size payments
after graduation, you do tend to see slightly better returns
in those initial years compared to the take out
the debt and invest method.
So was that it then?
Case closed, debt loses.
Well, not so fast.
Remember, that whole time is your greatest asset principle
we talked about earlier.
That really comes into play here.
See, while the post-college account might look like
it's pulling ahead early on,
remember, it's starting decades later.
Right.
And over the long haul,
that difference in time in the market,
that makes a huge impact.
What they found was that by retirement,
that debt alternative account strategy,
it still ultimately pulls ahead even in that scenario.
That's really interesting.
So it's not even just how much you save.
It's not even just about the interest rates.
It's when you start and for how long.
That's what really makes the difference.
It's the real paradigm shift.
It is.
This is fascinating stuff.
But, you know, we've got to be honest with themselves.
How realistic is that post-college,
super saver thing anyway?
I mean, life happens, right?
Oh, absolutely things come up.
And that's the other catch.
As appealing as it sounds in theory,
let's be real life happens.
It takes an incredible amount of discipline
to consistently make those hypothetical payments
a month after month, year after year,
without having that loan payment hanging over your head.
Yeah.
You know, unexpected expenses pop up.
Your job situation might change, priority shift,
life has a way of throwing curveballs.
Oh, tell me about it.
So maintaining that level of discipline savings
over decades, that's a call order for anyone.
I can already picture myself dipping into that
future millionaire fund for a vacation or two.
Exactly.
And suddenly that million dollars
isn't looking so impressive anymore.
All right.
All right.
So let's say someone is listening to all of this
and they're intrigued, they're thinking,
all right, this is fascinating.
But where do I even start?
What are the actual practical steps
to explore this approach?
Well, the good news is,
the paper does offer some great actionable advice.
First and foremost, open that investment account early.
And I mean, like yesterday early,
time is your biggest asset here.
Right.
So the sooner you can get started, the better.
And when it comes to choosing your investments,
remember, this isn't about chasing those
get rich quick schemes,
a well-diversified portfolio focused on low fees.
That's absolutely key.
This is where getting some professional guidance
is probably a good idea, right?
Because everyone's situation is a little bit different.
100%.
This isn't a one-size-fits-all kind of solution.
The paper strongly recommends consulting
with a qualified financial professional.
Right.
And not just any advisor.
You want to, with really specific expertise
in long-term financial planning,
look for designations like CFA, SEMA.
Don't just rely on those generic financial planning apps
for something this important.
This really requires more of a nuanced, personalized touch.
Right.
It's like the difference between using your map app
to get to the grocery store versus navigating
by the stars to cross an ocean.
Exactly.
You want somebody who really knows what they're doing.
Absolutely.
Now, all of that being said,
it's important to remember that there are always
going to be some inherent risks
when it comes to any investment strategy.
Of course.
The future is uncertain.
The market has its ups and downs.
And a lot depends on your personal financial discipline.
Right.
But this paper, it really challenges us
to rethink some of those long-held assumptions
about college savings and the true cost of playing it safe.
It really does.
It's given us all a lot to consider.
That's for sure.
It really has.
But before we wrap up,
there's one more thing I kind of wanted to touch on
that the paper mentions that really got me thinking.
It's this bigger picture aspect of all of it.
Okay, yeah, tell me more.
So, we've been talking about this whole debt
versus savings dilemma from our own wallets,
our own personal finances kind of perspective.
Right.
But this paper actually touches on something
that I think is even bigger than that.
It made me really kind of think about the whole picture here.
Like, what about how this whole concept might actually apply
to how we approach education funding as a society?
It is interesting, isn't it?
I mean, they were definitely focused
on the individual's experience,
but it does raise those questions about whether our current
systems, government policies, scholarship programs,
how we just view student debt on a larger scale.
Are those really aligned with this whole
long-term investment perspective?
It's almost like we're so busy, you know,
just trying to figure out how to pay for the next semester,
the next four years of tuition bills,
that we're not really looking at the bigger picture.
Right.
Investing early really is that powerful.
Yeah.
Shouldn't we be encouraging that more broadly?
Absolutely.
Imagine if instead of just offering those tax breaks
on savings plans, we actually explored ways to,
like incentivize early investing specifically
for education.
Right.
Or if we restructured financial aid in a way
that actually takes into account the long-term
earning potential of different fields.
Right.
This paper is a good reminder that we're not just talking
about abstract economic theories here.
Right.
These have real world implications for how we,
as a society, are essentially choosing to educate
future generations.
Yeah, it's a lot to unpack.
It is.
But I think the main takeaway, at least for me,
is that the power of starting early,
letting that money compound over decades,
that's undeniable.
It really is.
And well, like we said,
there are always going to be risks
when it comes to investing.
And of course.
This paper really forces us to think about
the true cost of playing it safe.
Right.
It's not just about the potential gains
that we might be missing out on,
but the missed opportunities to create a system
that's more equitable and sustainable for everyone.
Well, you have given us a lot to think about.
That's for sure.
A lot to consider.
Both for ourselves.
And then like we were just talking about
kind of zooming out and thinking
about the bigger picture as well.
So as always, thank you for joining us
for another deep dive.
Thank you.
Don't forget to check out the show notes.
We'll have links to the research
and all the resources that we mentioned.
Way good stuff.
And until next time, keep those brains engaged
and we'll see you on the next one.