In retirement, the average rate of return on your assets over time is not as important as when—and how big—the fluctuations are in those assets. If you have negative returns on your portfolio early into retirement, it reduces the principle available to recover from such downturns when big positive years follow. This is commonly known as sequence of returns risk (SORR), and the potential impact on a portfolio is truly jawdropping. You have likely seen the illustrations comparing two separate portfolios that start with $250k or $500k while assuming identical rates of return and withdrawal amounts over a 30-year period. They show that one portfolio may be depleted within the first 15 or 20 years while the other ends up leaving a healthy estate to heirs which is larger than the orginal investment—a difference due solely to the SORR. Recently, aging boomers with college-aged children are seeing this risk increase due to an unexpected combination—slumping equity markets, a sour economy and soaring higher education costs.
One component of the SORR trifecta is equity market performance. At this writing some $7.8T has vaporized from the global value of stocks in the worst market start to a year on record. The DJIA lost more than 1,500 points in just 10 days. The market loss in the U.S. alone would equate to Google, Facebook, Intel, Netflix and Yahoo simply disappearing.
A second component is the economy. According to data released by the U.S. Census Bureau early last year, all but the wealthiest Americans are still struggling to overcome the prolonged economic slump as household incomes remain below pre-recession highs while the cost of living continues to climb. Per the 2014 data released by the Russell Sage Foundation, from 2007 to 2013, median household wealth fell by a whopping 43 percent, from $98,872 to $56,335. Unemployment has also forced many families to raid or deplete their savings. In addition, the cost of health care has continued to skyrocket, and according to the Common Wealth Fund, 82 percent of Americans devoted 20 percent or more of their incomes to insurance premiums in 2013, spending an average of $16,000 per year. That’s almost double what families paid for health insurance just a decade ago.
The third component magnifying SORR for many aging boomers is that higher education costs are acting as premature retirement withdrawals. And those withdrawals are mushrooming. To attend a flagship university in my home state of Colorado, in-state families must be prepared to spend around $30,000 annually for total costs, while non-residents must be prepared to spend closer to $50,000 annually. With an average household income in Colorado of about $58,000 per year, most students must either borrow heavily to afford college, rely on their parents’ savings or both. And what if parents are trying to send two children to college? Or more? What if students also wish to attend graduate school in the future? For flagship schools, these costs can easily amount to multiple hundreds of thousands of dollars—amounts that most families can only muster if they are willing to make retirement fund or contribution trade-offs.
The upshot of all of this economic pressure is that it is forcing many middle and upper-middle income families to literally choose between saving for their retirements and sending their children to college. And if they choose the latter, the SORR hits them hard. A study released by Kaplan Test Prep found that three out of every five parents are putting less money away for retirement to meet college costs. According to T. Rowe Price’s Financial Trade-offs Survey, some parents have decided to put off retirement for another five or 10 years. A shocking 49 percent of parents even said they don’t believe they’ll be able to retire at all. No wonder many families still believe the recession has not ended.
Fortunately, there are ways to combat this risk. Some high quality educational options still exist in the form of small, public universities, often found in non-metropolitan areas—and many families are starting to recognize their quality and value. These small public schools often provide high-quality faculty, low student-teacher ratios, a breadth of majors, programs, clubs, extra-curricular activities and sports with a level of intimacy difficult to achieve in the world of larger flagship universities and their 500-person lecture halls.
Costs at these smaller public universities are often significantly less. Colorado has several of these public options, and they cost about $18,000 annually for in-state residents, and about $28,000 annually for non-residents. For these schools, a common four-year total debt load for those who borrow is about $24,000, which translates into a $247 per month (or $2,960 per year) loan repayment over 10 years, assuming a 5 percent interest rate. For students who must borrow to graduate from a larger flagship school, it is not uncommon to receive $60,000 or more in total loans, which translates into at least $617 per month (or $7,400 per year) over ten years.
Lastly, more families are starting to realize that spending more on college does not necessarily equate to greater value. In fact, studies conducted by the National Bureau of Economic Research have repeatedly shown that spending more on a college education does not necessarily correlate with a better job or higher paycheck. With all of that in mind, families should not feel guilty about making the choice to send their children to a reasonably priced college.
By making the smart choice to send their children to an affordable institution, middle-class and upper-middle class families can still provide their children with a great education while not falling victim to SORR. In some cases, they may be saving their own retirements—because the last time I checked, it was pretty difficult to get a loan or scholarship to pay for retirement.
Dr. Gregory B. Salsbury is president of Western State Colorado University following a 25-year career in the financial service industry.