Education Fund and Inflation

Assume that you wish to save $100,000 for the tertiary education of your child in 20 years time.

If you expect to earn an average return to be 5% a year, you need to save $3,020 a year.
In 20 years time, the cost of education would have increased, due to the impact of inflation. If inflation is an average of 2% per year, the cost would have increased to $148,000, i.e. an increase of 48% over 20 years.

To get the higher sum of $148,000, you will need to save 48% more, or $4,470. That is a lot of money, especially at the earlier years, when your income is still at a more modest level (i.e. has not reached the peak for your career).

A better approach is to have a saving plan that increases with your salary. If you assume that your saving can increase by 2% per year, you can save a smaller sum at the start.

Here is an easy way to calculate the amount that you need to save to produce $100,000 (in real value) in 20 years, allowing for inflation at 2% per year.

If you expect to earn an average of 5% per year, and you wish to allow for inflation at 2% per year, you use a “real” interest rate of 3% in your calculation (i.e. nominal rate of 5% less inflation adjustment of 2%).

To get $100,000 in real value in 20 years’ time, you need to save $3,720 yearly in real terms, i.e. the saving has to increase by 2% every year.