Compound Interest to the Rescue

Eric • 18th May 2007 • Family, Finance

Albert Einstein said something about compound interest, maybe, that it’s the most powerful force in the universe. While it can work against you, it can also work for you.

Take, for instance, saving for college. I figure it’s going to cost me $192,594.39 ($51,418.72 Jason, $66,148.45 Becca, $75,027.22 Morgan) to send the kids each to a 4-year, in-state public school. That’s living at home, and not including any supplies.

However, to get there, I only need to save $109,445.58, or 56.8% of the total bill. Why? Because of compound interest! If I save $1 today in Morgan’s account, it’ll be worth $6.11 after 21 years, when she graduates. Remember

A=Pe^rt

? What that means is the $1 is worth $1.09 after year 1. Then add 9% onto that, and keep going for 21 years. It’s not $0.09 per year, but 9% of the previous year (9% of $1 gets us to $1.09, but 9% of $1.09 gets us to $1.18(81), then $1.29(5029) and so on and so on).

Now Jason’s already 8, so I don’t have 21 years to save for him. I used a big Excel spreadsheet (like always) and charted the years, and columns for annual savings. Starting with a base, I need to add 10.65% to Jason’s total, 5.75% to Becca, and 4.25% to Morgan year after year to fully pay for college. This is really only a 7% increase per year, until Jason’s done with school, when it drops 47%, then when Becca is done, it drops 54%. 7% is something I can live with.

I assume a 9% annual growth on their 529 accounts.

So while college will COST $192,594.39 (between 2018 and 2027), I’ll only have to save $109,4454.58. The remainder comes from compound interest.

Of course, I somehow have to save for this while sending all three of them to private grade schools. Either that… or we move