This is part one of a series on the long term benefits of dividend investing:
I’m a planner. If you are reading this you probably are too. Paying for college is nothing to get excited about, especially as tuition costs keep going higher. For parents with children being born in 2013 the costs are jaw dropping. This article from CNBC estimates that 16 years from now annual tuition costs to be $40-70k per year including room and board. That means a 4 year education will cost between $160-280k. That’s enough to frustrate parents and make them feel like college costs will hurt their chance to save for retirement.
While I haven’t decided exactly how much of my kids tuition I am going to pay, those kinds of numbers make me want to offer them a lump sum of money just to stay out of college. Could there be better ways to use that $200k? There just might be.
I hope costs do not keep rising and the tuition bubble pops sometime soon. At some point the value vs costs just doesn’t make sense anymore. We’ll have to make that decision down the road.
Pay with Dividend Income
Back to the point of this article – paying for college with dividend income. Most people think about saving up for college with the piggy bank mentality. Put aside enough cash in a safe investment vehicle and when the time comes start making withdraws. Putting money into mutual funds or index funds really isn’t that different of an approach except that you are likely to achieve much better returns over the course of 15-20 years.
My plan is a little different. I want to pay part (if not all) of my kids college tuition with dividend income.
Instead of selling off chunks of a portfolio and reducing its overall value to pay for each year of school I will be using the income my investments produce each year to cover costs. That way the portfolio keeps growing as the the stock prices appreciate. The dividend income continues to grow each year as well as companies increase dividends.
At the end of this college tuition adventure I’ll be left with a portfolio that is worth more than when college started. And it will be paying more dividend income each year as well which will help contribute to our retirement.
What It Takes
I’m going to use my own situation as an example. I understand that everyone is in different stages of life and that this approach really works best for families with infants and children yet to be born. I personally have a 1 year old and more on the way. That does not mean that its too late for someone that has been using a different method. You can always buy dividend growth stocks.
The goal is to create monthly dividend income to pay for college tuition. Let’s get started. I’m going to use my dividend calculator to make all the calculations for us.
Starting Portfolio Value: $0
Annual Addition: $24k ($2k per month)
Average Yield: 3.5%
Expected Stock Appreciation: 5% (annually)
Dividend Tax Rate: 15%
Note: 5% stock price appreciation means an assumed 5% annual dividend growth. This is a conservative estimate that I expect will be easy to find and achieve.
After 17 Years:
New Portfolio Value: $811k
Annual Dividend income: $28k
Now $28k doesn’t quite cover the estimates from the article but during those college years I could stop contributing to the fund (adding $24k per year) to help pay for tuition. If I don’t reinvest the dividend income for 4 years the portfolio will still grow and the dividend payouts will keep growing as well because I’ll be invested in dividend growth stocks. In fact 4 years later that $811k will have grown to $1.1M and I’d now be receiving $38k in annual dividend income. Obviously that will help pay for child #2. After another 4 years (still making no new portfolio contributions) the portfolio will be worth $1.5M and pay $52k in annual income.
This whole idea is based on a world of predictable returns. Admittedly the market is not perfect but I hope that over 17, 21 and 25 year periods this will average out to work as I’ve planned.
As I noted earlier each situation is different. Some of us have kids that are in their teens and using this approach may mean taking a lump some of cash and moving it into dividend growth stocks. For others I hope its a new perspective about the future. I often hear parents complaining about the impact college tuition will have on their retirement accounts. Using this approach allows parents to hold on to their original investment principal and watch it grow while kids are still in school.
Please Note – I am not a financial advisor. While this approach works for me I am not making a recommendation for anyone else to follow. There is no guarantee of returns. Investing money is risky. Consult a financial advisor before taking any action.