For a 529 college savings, when they say you get a 6-10% return, how do u do the math for that?

Question

i know that whatever you have in it say 20,000, do you times that by 6 or 10%? or does it work different?

is the 6-10% a apy interest rate?

Answer 1

529 plans are not like bonds. They do not have a fixed return because they are predominantly in stocks. Stock returns vary wildly from year to year. We've had great returns over the last three years, other times they are negative. Over the very, very long run, stocks average about 7% capital gains plus about 2% dividend yield (total of 9%) - but have gone long periods of not even coming close to averaging these returns.

The bottom line is that you don't know what the returns will be like over the short or long term. There is a trade-off of risk for return. The higher the risk, generally the higher the return. And, FYI, yes it is APY.

When you invest your $20,000 in a 529 fund, it should return somewhere between negative 10% and positive 20% with an average around 9%. Let's say you are investing for 20 years for 9% average returns. This is compound growth, so the math is like this:

Future value = Present Value x (100% + APY)^(years)
$112,088 = $20,000 x (100% + 9%) ^ 20


However, don't forget about inflation. We've been spoiled by low inflation for a decade but those of us old enough to remember the eighties remember very high inflation. So, before you get all excited that you've saved about $100k for your kid's college, remember that inflation is going to eat up about 3 percentage points per year (for a "real" APY of 6%). This also assumes that college costs don't rise faster than the rest of inflation. However, we've all seen that college and medical costs have continued to rise faster than baseline inflation for quite some time. Plus, you're not going to have 20 years. More likely than not, you've got less. Let's say 10 years.

The new math is:
$35,816 = $20k x (100% + 6%) ^ 10

Bottom line: nice job on starting, you've paid for 2 years of in-state tuition but your kid is going to need to get a job to pay for books, housing, food, beer money and spring formal dance tickets.