Episode Details

It was reported over the weekend that private school fees have increased by 3.6% over the past year. However, the longer-term trend is closer to 5% p.a. Private school fees are tipped to soon exceed $40,000! That is a big hit to after-tax cash flow. This blog compares three financial strategies you can use to fund future school fees.

What is the future cost?

There are two things to keep in mind with respect to future education costs. Firstly, the average rate of fee increases is close to 5% p.a. Secondly, these expenses must be paid from after-tax income – so you have to earn a lot more pre-tax in order to meet these costs.

A child born this year will most likely start secondary school in year 2031. Assuming fees increase 5% p.a. and inflation remains at 2% p.a., the total cost of secondary private school education will be $280,000 in today’s dollars. A parent will need to earn at least $460,000 before tax (in today’s dollars) over a 6-year period to meet these costs – an average of $75,000 p.a. per child.

I am sure you agree that this is a substantial cost and one that you must plan for as early as possible.

Steer clear of education funds

The most prominent education fund producer is ASG. It creates structured savings plan so that parents will be better positioned to meet future education costs. However, their fees are high and investment returns are terrible. Parents would be far better off following one of the lower-cost, more transparent options below.

Strategy One: Park savings in your home loan

The best place to save money is to park it in your home loan and redraw it whenever you need it. The reason being is that the home loan interest rate is much higher than the deposit rate. At best, you might receive 2.5% p.a. in interest for money in a savings bank account. The home loan mortgage interest rate is currently around 4% p.a.

I completed my financial projections using a home loan interest rate of 5% over the next 18 years (the average rate over this time will likely be higher – but I’m being conservative). I worked out that parents would need to direct additional cash of $1,200 per month into their home loan over the next 18 years in order to fund their children’s school fees. That is, in year 2031 they would redraw these extra repayments from their home loan to pay for their children’s school fees as they are incurred.

This approach (i.e. $1,200 per month for 18 years) costs $258,000 in after tax dollars – slightly less than the $280,000 above – because of the interest saving generated by the extra repayments.

This approach is very low risk because your return (being the home loan interest you will save) is certain. That is, home loan interest rates will almost always be between 3.5% and 8% p.a.

You can also park money in an offset linked to an investment loan – although it is less effective than a (non-tax-deductible) home loan.

Strategy Two: Invest in the share market

This option includes investing a regular amount in the share market. You don’t need to ‘pick’ shares in order to implement this strategy. Instead, you can use a low-cost, diversified index fund from Vanguard to do this. This means you only need to buy shares in one stock (codes are VDHG or VDGR for example) each month in order