How you can avoid college debt: a basic guide

I've always seen college debt as an albatross -- a heavy, expired bird that becomes a financial burden over time. That's why I'm writing this new column for CBS MoneyWatch: I want to share with you what I've learned not only in my own journey, but in helping others find a debt-free degree.

I talk with parents on a regular basis, speak about this subject and have interviewed people all over the country. Sadly, some of the more than 42 million Americans holding more than $1.3 trillion in college loans are carrying debt into retirement. Many, though, still have a chance to avoid it.

I didn't carry any debt after I earned my two degrees from the University of Illinois-Chicago and I believe that most students can avoid onerous loans today if their families plan carefully.

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So I'll be presenting college financing as a form of comprehensive family financial planning. While I think college -- and lifelong learning -- is important to your economic well-being, you can make some meaningful decisions about going into debt for pay for it.

Here's my college financing philosophy in a nutshell: You should look for a "best fit" for the right campus environment and programs while searching for a "best value" that involves little or no loans.

One of the first legs of everyone's college planning journey should be saving for college. Families should save early and often. Get everyone involved. That means parents, grandparents, aunts and uncles.

When my two daughters were born, we set up college savings accounts called 529 plans. Offered by states, these programs allow you and other family members to save for a child's college through professionally managed mutual fund portfolios. More than $250 billion is invested in these programs nationwide.

While some states give you a tax break for contributions, all of them allow for tax-free withdrawals -- if the proceeds are used for college expenses such as tuition and room and board (they will even cover computer purchases).

With 529 plans, you don't have to invest in your home-state's program, although it may in fact offer you the best tax incentive to contribute. For a complete list of plans and features, see collegesavings.org.

The managers of 529 plans make it easy to invest. If you feel so inclined, you can pick your own mutual funds or choose an "age-adjusted" portfolio that pre-selects a group of funds that reduce stock-market risk the older your child gets. That's my preferred mode of investing, since picking individual funds is a risky business.

Not every 529 portfolio is created equal, though. Those sold by brokers or advisers charge commissions, which will reduce your total returns and may have higher expenses. Buy what are called "direct sold" 529 plans whenever possible. They don't charge commissions, so more of your money is invested.

Fund managers within 529s, who generally hail from the largest mutual fund groups like American, Fidelity, T. Rowe Price and Vanguard, have varying investment results. But as with eyeing any mutual fund investment, it's a red herring to pay attention to past performance. Even if a manager has a great year or two, he or she can't guarantee it going forward.

What matters most is a low-cost, passive approach -- you leave the funds alone and don't time the market -- combined with rock-bottom expenses on fund management. Since you're (ideally) investing over a period of nearly 20 years, the lower the expense "ratio" on the internal funds, the greater the potential return. The ratio is an annual percentage of money paid to managers based on the amount of money you have on deposit.

"Fees have predictive power. Over the long run, low expenses tend to translate to better returns, as the basic math of compounding wins in the end," notes Leo Acheson, an analyst for Morningstar, the Chicago-based financial information company that rates 529 plans and the mutual funds within them.

Searching for the lowest-cost 529s is a good start on your savings journey, but again, this strategy is no guarantee you'll experience the best returns over time, which you can't predict anyway.

Expenses vary widely depending upon what fund you're choosing. The money-market fund in the Florida plan, for example, doesn't levy a management fee. Stock funds, of course, charge more, but you have to look at the total average cost of a plan. The New York 529 College Saving program, for example, charges 0.16 percent across the board, which is a good deal.

Fees loom large in 529 investing. If one plan charges 0.20 percent annually, you'll save $16,340 on a $5,000 investment with a 7 percent annual return over 18 years, notes savingforcollege.com. Double that annual management fee to 0.40 percent annually, and your balance after nearly two decades is only $15,798. Of course, the more money you have invested, the bigger the difference in total return.

The key gauge in telling whether you're getting a reasonable 529 portfolio is performance minus fees, preferably over a decade. Then you have to factor in any tax savings offered by your home state, so always vet your state's 529 program first before looking elsewhere. It pays to shop around.

  • John Wasik

    John Wasik is the author of The Debt-Free Degree and 15 other books. He writes and speaks regularly on personal finance issues throughout North America.