Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / How Inflation Adjustments Change College Savings
Transcript
- Lucas: Let’s start with a number that keeps me up at night, even though it’s not a stock ticker. It’s the gap between general inflation and actual tuition inflation. Over the last twenty years, the Consumer Price Index has averaged around three percent annually. But private university tuition has climbed closer to five or six percent. That extra two percent is where your savings account silently bleeds. Luna: Right, because people see their balance go up and think they’re winning, but if the goalpost moves faster than their progress, they’re actually falling behind. It’s a purchasing power problem, not just a savings rate problem. Lucas: Exactly. And here is the specific trap most parents fall into. They pick a 529 plan because it offers a state tax deduction, which is great, but they leave the money in a conservative fixed-income bucket because they are terrified of losing principal. They want safety. But safety from what? From market dips? Or from inflation eating their child’s future? Luna: So you are saying that for a kid who isn’t starting college for another twelve years, playing it too safe is actually the risky move. Is there data on how often families realize this before the first bill arrives? Lucas: I don’t have a precise percentage, but my read of the advisory space is that most families wait until age seventeen to rebalance. By then, the equity exposure is gone, and they are holding cash equivalents that barely keep pace with general inflation, let alone tuition spikes. Let’s look at a concrete example. Imagine a family in Ohio contributing to the Ohio Education Advantage plan. They start when their child is born. If they stay in a conservative bond fund yielding four percent, they might hit their nominal target. But if tuition grows at five percent, they end up short by roughly fifteen percent of the total cost by graduation day. Luna: That fifteen percent gap usually gets filled with student loans. So the decision made at birth dictates whether the child graduates debt-free or starts adult life with interest compounding against them. Does the plan structure itself offer any protection against this? Lucas: Most state-sponsored 529 plans do not have a dedicated 'inflation-protected' fund like some retirement accounts might. Instead, they rely on asset allocation models. These are target-date funds that automatically shift from aggressive equities to conservative bonds as the student approaches college age. The key insight is that the 'aggressive' phase needs to be aggressive enough to beat tuition inflation, not just CPI. For an eighteen-year horizon, we are talking about heavy equity exposure early on. Luna: But aren’t there periods where equities crash right before college starts? Like what happened during the pandemic dip? Parents panic and sell low. Lucas: That is the behavioral risk. The system is designed so that if you started eighteen years ago, you would have had several market cycles. The drawdowns in the middle get smoothed out by the recovery. The danger is only if you are forced to withdraw during a downturn. But for a typical family, the sequence of returns risk is managed by time. The question is whether your current allocation assumes the economy stays flat or grows. Most conservative portfolios assume zero real growth. That is a dangerous assumption for education funding. Luna: It feels counterintuitive to tell parents to take more risk when they are already stressed about money. How do you convince someone to hold volatile stocks for a goal that is both expensive and non-negotiable? Lucas: You reframe the risk. The risk isn’t market volatility; the risk is running out of money. If you play it safe and lose purchasing power, you fail the goal completely. If you take calculated equity risk and have a bad decade, you still likely have enough capital to cover a significant portion, leaving less need for loans. It’s about probability of success, not avoidance of pain. Look at Berkshire Hathaway’s long-term trajectory. Even through recessions, compound growth wins. A 529 plan is a decades-long bet on human potential and economic productivity. Luna: So the strategy is essentially betting on the broader economy rather than trying to time the markets. Are there specific funds within these plans that track this better? Lucas: Typically, the broad market index funds within the 529 portfolio are your best tool. S&P 500 index funds or total market funds tend to outperform active managers over long horizons due to lower fees. Lower fees mean more money stays invested to fight inflation. Every basis point you save in expense ratios is a direct hedge against erosion. If a fund charges one percent and another charges two percent, that one percent difference compounds massively over eighteen years. Luna: It’s amazing how much math happens in the background. People focus on the deposit amount, but the fee drag is actually a huge silent killer. What about grandparents? They often step in with gifts. Lucas: Grandparents are tricky because of ownership rules. If a grandparent owns the account, it can affect financial aid calculations differently than a parent-owned account. But regarding inflation, the same logic applies. If a grandparent contributes a lump sum ten years before college, that money has less time to grow. It needs a slightly more balanced approach, but still tilted toward growth if the child is under ten. You cannot treat a grandparent’s gift as a savings account. It must be invested. Luna: Does the type of school matter? Like, does public university tuition rise at the same rate as private? Lucas: Public university tuition rises slower, usually closer to general inflation, because states subsidize a large chunk. However, state subsidies are politically vulnerable. In tight budget quarters, states often cut higher education funding, pushing costs onto students. So even public schools carry an inflation risk that exceeds the CPI. Private schools have no such buffer, which is why their costs spiral. Both require an investment strategy that expects real growth. Luna: This brings us to the timing issue again. If I have a teenager and I haven’t done this, am I out of luck? Lucas: Not out of luck, but you have lost the luxury of time. You now have to make harder choices. You might need to contribute more aggressively to catch up, or you might need to accept that the 529 will cover only half the cost. The math doesn’t lie. With only four years left, you cannot rely on ten-percent annual returns. You are looking at moderate growth, maybe five to seven percent. You have to adjust expectations downward. It’s a correction of optimism, not a failure of planning. Luna: That adjustment of expectation is probably the hardest part for parents. They want to promise their kids everything. Reality checks are tough. Lucas: It is. But here is the thing: transparency helps. Showing a teenager the actual cost of attendance versus the projected savings builds maturity. It turns a vague anxiety into a concrete problem to solve. Maybe they work summers. Maybe they apply for more grants. Maybe they choose a different major. Financial literacy starts with seeing the numbers clearly. Luna: Do you see families using other tools alongside the 529? Like custodial accounts or trust structures? Lucas: Some do, but those add complexity. For most people, sticking to the 529 and optimizing its asset allocation is the highest leverage move. Adding complex trusts introduces legal fees and administrative burdens that eat into returns. Unless you are dealing with estate tax issues, simplicity wins. Keep it in the 529, keep it diversified, and check the fees annually. Luna: Checking fees annually. That’s actionable advice. Most people set it and forget it. We need to remind them to look under the hood. Lucas: Absolutely. Set it and check it. Every January, look at the expense ratio. If you have been in a high-cost actively managed fund for five years, switch to the index option. The performance difference will be obvious in your statements. You will see the drag disappear. Luna: It’s funny how we talk about inflation like it’s an abstract economic concept, but here it is destroying our children’s futures. It makes the investment choice feel moral, almost. Lucas: It is moral. It’s about stewardship. You are stewards of resources that belong to the next generation. Acting responsibly means respecting the power of compounding and the threat of inflation. It’s not about getting rich; it’s about ensuring access. Luna: Before we wrap this deep dive, we should mention something about how we keep this show going. We deliberately don't run ads on these episodes. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Lucas: Yeah, listener support is what allows us to dig into these details without worrying about advertiser pressure. It keeps the conversation focused on what actually helps families. Thanks for keeping the lights on. Luna: Back to the numbers. If you are watching this in September of twenty twenty-six, the interest rate environment is stabilizing. Bond yields are decent, but equity valuations are still stretched in some sectors. How do you advise balancing that right now? Lucas: Stretched valuations are normal in bull markets. Do not try to time the top. If your child is young, stay invested in the broad market. Volatility is the price of admission for higher returns. If your child is graduating next year, yes, move to cash. But for the long horizon, patience beats precision every time. Luna: Patience over precision. I like that. It takes the emotion out of the daily news cycle. You just follow the plan. Lucas: Exactly. The plan handles the emotion. You handle the contributions. Let the market do the heavy lifting. It sounds simple, but executing it requires discipline. Especially when the headlines scream fear. Luna: Do you think parents worry too much about picking the perfect fund? Like, is there a magic bullet? Lucas: There is no magic bullet. There is just diversification and time. Any fund that promises to beat the market consistently is selling a fantasy. Stick to the low-cost index funds provided by your state plan. They are boring, reliable, and statistically superior over long periods. Boring is good for education savings. Luna: Boring wins. That’s a mantra worth repeating. It counters the urge to chase hot tech stocks or crypto trends with money meant for tuition. Lucas: 100 percent. When you see a stock double in a month, it’s exciting. But that excitement doesn’t pay for textbooks. Steady, predictable growth pays for textbooks. And eventually, it pays for the degree. Focus on the destination, not the ride’s speed bumps. Luna: Where do you see the biggest mistake happening this quarter? Is it inactivity or wrong activity? Lucas: Inactivity. Too many accounts sit empty because people think they need to save a lot to start. Start with twenty dollars a month. The habit matters more than the initial size. Once the account exists, the psychology shifts. You become a saver. Then you can increase the amount later. Luna: Start small, stay consistent. It’s the classic advice that works because it’s sustainable. High intensity efforts burn out. Low intensity habits endure. Lucas: Precisely. Sustainability is the key to beating inflation. You have to be able to keep investing for eighteen years without quitting. Small steps ensure you stay in the game. Luna: As we close, what is one final thought for the listeners who are feeling overwhelmed by the cost of college right now? Lucas: Don’t let perfection prevent action. Open the account today. Pick the default aggressive model. Set up an automatic transfer of any amount. You have fixed the process. Now you just need to let time work. The rest will follow. Luna: Fix the process, let time do the rest. A solid takeaway. Thank you for joining us on this deep dive into inflation and savings. Lucas: Thanks for listening. Stay curious, and keep your eye on the long term.