Quizmaster, Doug Hutchinson, presents his quiz for the month.
Here, Doug discusses strategies for saving for college.
Consider this Scenario:
Your friends Martha and Jack are planning on setting up a college savings investment plan for their toddler, Max. They are examining a few different options for this investment plan and have asked for your help.
One option they are considering is to start contributing now with a $4,000 initial contribution and then adding $1,000 per year for the next 17 years. Assume the contributions occur at the beginning of each year including the first year.
The other option they are considering is to start contributing 5 years from now with a $5,000 initial contribution and then adding $1,500 per year for the next 12 years. Assume the contributions occur at the beginning of each year including the first year.
Assume the investments return 7% per year for each of the 17 years. Also assume that Martha and Jack are using a tax deferred investment account.
Which option will lead to the highest value at the end of 17 years when Max is ready to start college?
Solution:
Option 1:
Year 2017 Starting Value = ($4,000 initial contribution +$1,000 annual contribution) = $5,000
$5,000 x 1.07 = $5,350 = Ending Balance Year 2017
Repeating this process through the end of Year 2033 leaves the college fund with a balance at the end of the time period of $45,634.
Option 2:
Year 2022 Starting Value = ($5,000 initial contribution + $1,500 annual contribution) = $6,500
$6,500 x 1.07 = $6,955 = Ending Balance Year 2022
Repeating this process through the end of Year 2033 leaves the college fund with a balance at the end of the time period of $39,972.
Option 1 will lead to a higher ending value ($45,634) than Option 2 ($39,972) despite the fact Option 2 includes $23,000 in contributions while Option 1 includes only $21,000 in contributions. In this case, the earlier starting time in Option 1 versus Option 2 (now versus 5 years from now) more than offset the difference in contribution amounts.
To get even more advice, Martha and Jack should consider contacting a financial planning expert to assist them with their unique financial planning needs.
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This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
