We instinctively want to protect and nurture our kids. Sometimes well-intentioned families start saving for college while they still have high cost debt, such as credit cards.
Sadly, that strategy is almost guaranteed to lose money over the long-term.
Why? Credit cards charge much more than you can reasonably expect to earn on your investments over any reasonable timeframe. (Average rates are ~15%, many charge over 20%!)
Example of What NOT To Do
Say you carry a credit card balance of $1,000 at 15%.
You get a larger-than-expected holiday bonus. Yay!
Excited to start saving for college, you invest $1,000 in a college savings account.
A reasonable long-term rate of return assumption is 6% / year. Some smart, reasonable folks (like Jack Bogle, founder of Vanguard) note it could be as low as 4%. Warren Buffett has talked about 6-7%. We'll say 6%.
6% is definitely an assumption, but know that there is absolutely no credible case to be made that long-term stock market returns will match or exceed credit card rates. Anyone who tells you that your long-term rate of return on your investments will be 15-20% is either lying, deeply self-delusional, or dangerously misinformed.
One year later:
You've paid $150 interest on your credit card ($150 = $1,000 * 15%)
You've earned $60 on your college savings account ($60 = $1,000 * 6%)
= You've lost $90 ( $90 loss = $150 loss + $60 gain)
Ouch!
Using the $1,000 you put in college savings to pay down that credit card debt would have been a better choice because you would not have lost money.
It's not always easy to "see" you're losing money: you look at the college savings account statement and think "wow, we made $60!"
You pay your credit cards on time and feel like you're "keeping up".
But your family's net worth is declining.
This illustrates the importance of being free from high cost debt before you start saving for college.
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Ready to start saving for college? Check out the interactive AboveBoard College Savings Guide
