Key Post What is the best way to save for children's education?

Gordon Gekko said:
I would assume a 5% return on average from the invested portion of my capital
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Hi Gordon

Are you assuming an annualised 5% return, net of all costs and taxes, on the equity portion of your portfolio only? Personally, I think that's rather optimistic.

Incidentally, and apologies in advance if this sounds overly pedantic, the average annual return is not the same thing as the annualised rate of return (aka the CAGR).

Simple example -

Portfolio A
Invest €100
Year 1 - 20% return
Year 2 - 0% return
Result - €120

Portfolio B
Invest €100
Year 1- 10% return
Year 2 - 10% return
Result - €121

Portfolio A and B had the same average annual returns but different annualised rates of return.

This example also explains why volatility harms portfolio returns.

I still think paying down a mortgage invariably has the higher expected return (particularly on a risk-adjusted basis) given our tax code.
 
So to get 5% net return, you need

Gross return 10%
Less costs 1%
= 9%
Less 40% tax 3.6%
=5.4%

I am a great fan of the stock market but it's hard to see it making 10% consistently.

Brendan
 
even if you do get that 10% gross return

This gives you 60% x 5% = 3% + 40% x 1% = .4%

So that is a return of 3.4%

Most people are paying that on their mortgage.

So clear the mortgage and there is no risk. No volatility. No admin.
 
Firstly, it’s not as simple as that. The investment is rolling-up tax-free for 8 years. What have global equities delivered, on average, over time, 8% a year?

So after 8 years of compounding, my investment of, say, €100,000 should be worth €185k. Let’s assume my costs are 1%, so if the average balance over the period was €142.5k, my total fees are €11,400. So I only have €173,600. I pay 41% tax on the €73,600, which leaves me with €143,500. €43,500 over 8 years is an average return of 4.8%.

As you know, I’m a big advocate of accelerating one’s mortgage repayments. However, when you know that you’ll need cash for something like education, it makes sense to set that cash aside. The biggest issue with throwing money against one’s mortgage is that you mightn’t be able to get it back when you need it. I would prefer to have the education money set-aside and invested separately. Comparisons with the return that one gets on one’s mortgage are not valid; it’s not relevant. Someone could get an even better return by making an AVC. The point is that they need access to the money for a specific purpose. It’s not just investing for the sake of it, in which case I’d always repay my mortgage.
 
Gordon Gekko said:
So after 8 years of compounding, my investment of, say, €100,000 should be worth €185k. Let’s assume my costs are 1%, so if the average balance over the period was €142.5k, my total fees are €11,400. So I only have €173,600. I pay 41% tax on the €73,600, which leaves me with €143,500. €43,500 over 8 years is an average return of 4.8%.
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That is not the right way to look at it.
What gross return do you expect? 8%
Less 1% costs
=7%
Less 40% tax
= 4% net.

In reality, you can estimate that the net return will be about half the gross return before charges and taxes.

And you are taking very significant risks.

Paying down the mortgage is the equivalent of a gross return of twice the mortgage rate with no risk.

You can review this strategy with 5 years to go. Your mortgage payments will be a lot less. So you can save a lot more.
You might be moving house around that time. You can effectively remortgage then if you want.

Even if you are not moving house, there is a very good chance that in 18 years, the system will be different and you will be able to take out a mortgage for educational needs.

Brendan
 
Hi Brendan,

I don’t think that’s right at all.

- You don’t pay the tax each year so there’s eight years of gross-roll-up
- I don’t think it’s fair to say that repaying one’s mortgage is the equivalent of a gross return of double the rate; with CGT at 33%, fund tax at 41%, and marginal income tax at 52%, it’s less than double on a blended basis which would be fairer
- Even taking your figures, with an 18 year time-horizon, double a mortgage rate of 2.5%, i.e. 5% gross, is still a way off the long-term average of equities
- I would not tie-up money that’s needed for something by throwing it against my mortgage; one cannot depend on banks to come through at some future point. A “good chance” is not enough. Education funds should be kept separate
 
Gordon Gekko said:
What have global equities delivered, on average, over time, 8% a year?
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Since the end of 2000, the MSCI World index has produced an annualised return of 3.32%, with all dividends reinvested.

[broken link removed]

After deducting all investment costs and taxes, you would have been doing well to achieve an annualised net return of much more than 1%.

Maybe the next 20 years will be kinder. Maybe not.
Gordon Gekko said:
The point is that they need access to the money for a specific purpose.
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Sure but the education costs don't need to be discharged all at once. Like most lifestyle expenses, they are spread out over time and can be discharged out of current income.

To me, having a separately earmarked "education fund" is another example of mental accounting. Money is fungible at the end of the day.
 
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Sarenco said:
Since the end of 2000, the MSCI World index has produced an annualised return of 3.32%, with all dividends reinvested.

[broken link removed]

After deducting all investment costs and taxes, you would have been doing well to achieve an annualised net return of much more than 1%.

Maybe the next 20 years will be kinder. Maybe not.

Sure but the education costs don't need to be discharged all at once. Like most lifestyle expenses, they are spread out over time and can be discharged out of current income.

To me, having a separately earmarked "education fund" is another example of mental accounting. Money is fungible at the end of the day.
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Sarenco, two points:

- You regularly fall back on the last 20 years as your killer argument; it’s almost the only 20 year period where things have been as “bad”. In virtually every observation period, bar the one you cite, the numbers have worked in an investor’s favour. Continuously defaulting to the one with the tail-end of the dot.com crash, the Global Financial Crisis, and Covid-19 serves no purpose other than to illustrate that 1) Even over a shocking period of events, returns are still positive 2) If that last 20 years have been so-so and every other 20 year period has been better, surely it’s more likely that the next 20 years will be okay (mean reversion etc).

- The point about mental accounting and money being fungible is deeply flawed. Money offset against a mortgage isn’t necessarily accessible; circumstances can change, e.g. banking policies or loss of income. If you know that education will cost €X, there is very little wrong with setting aside €X from a planning perspective.

I think it’s misguided to suggest spending €X in the hope of being able to pull it together at some later date whilst being at the mercy of banks.

And it is misleading to cite one 20 year period where investors still did okay as reason not to invest. It should be looked at another way; even the one relatively rubbish period was still okay; whereas the vast vast majority of others were stellar. So my most likely outcomes are that I’ll do really over 18 years. There’s a small chance it’ll be so-so but the overwhelming probability is that I’ll be in clover.

“Oh no! But some guy who invested in 2000 hasn’t done well!” But what about the hundreds of guys who invested over 20 years from every other start-point? How did they do? Pretty well in almost every observation.
 
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Gordon Gekko said:
You constantly fall back on the last 20 years as your killer argument; it’s becoming a little tiresome
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I'm sorry if you find it tiresome Gordon but investors don't earn average returns. They earn whatever return the market throws up over their particular investment period - which is obviously unknowable in advance.

Stock market returns vary massively over different time periods. I know people crave certainty but that is elusive when it comes to future stock market returns.

There is a very good reason why every offering document reminds investors that past performance is not indicative of future returns.

Also, bear in mind that we are discussing whether it makes sense to invest outside a pension while carrying a mortgage. So it's the net return on your investments, after all costs and taxes, relative to the weighted average mortgage rate over the relevant time horizon that matters.

The expected return on equities is only one element of that equation.
Gordon Gekko said:
The point about mental accounting and money being fungible is deeply flawed
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Ok, let's substitute "food fund" for "education fund".

You can be pretty sure your family will still need to eat in 15 years' time! Would you similarly advise somebody to build up a food fund before paying down a mortgage ahead of schedule?

What about other anticipated future lifestyle expenses?
 
Sarenco,

The theoretical person doesn’t need €229k to buy food over the period.

And we’re not talking about overpaying mortgage vs investing personally; we’re talking about saving/investing for education.

If one is saving for something, it’s wrong to throw money against one’s mortgage in the hope of borrowing it again at some future point. Especially if it’s important, and one has the capacity to provide now which might not be there later.
 
Gordon Gekko said:
And we’re not talking about overpaying mortgage vs investing personally; we’re talking about saving/investing for education.
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Paying down a mortgage ahead of schedule is a form of saving/investing!

You are essentially arguing in favour of pre-funding one anticipated future expense ahead of discharging a current liability. To me, that's simply mental accounting but you are obviously free to take a different view.
 
Gordon Gekko said:
If one is saving for something, it’s wrong to throw money against one’s mortgage in the hope of borrowing it again at some future point.
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I don't disagree.

But I am arguing in favour of paying an anticipated future expense out of anticipated future income.
 
Sarenco said:
I don't disagree.

But I am arguing in favour of paying an anticipated future expense out of anticipated future income.
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Income which may not be there! It’s called risk management. If I know that the education is going to cost €229k and I can afford to set-that aside now, I should do that now. Not lob it off the mortgage in the hope of being able to borrow it again or still having the same earning capacity.

I’d consider myself reasonably savvy financially. Nonetheless, when my wife asked whether we could try to put aside the expected cost of the kids’ education in cash, I agreed. Personally I’d do the equity investment but she feels better this way so it’s no big deal as far as I’m concerned. But no way would I take it and pay it off the mortgage.
 
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Sarenco said:
Equally, the anticipated expenses may not materialise.

Either way, a known liability (the mortgage) will remain outstanding.

How you propose to pay the mortgage if you have no income?
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Will the cost of private schooling and third-level fall?!

The mortgage will continue to fall over time as normal.

a) It is very difficult to get someone out of their PPR, and b) At a minimum, one can probably pay one’s mortgage; it’s the €229k extra that might be the issue if income falls
 
Gordon Gekko said:
Will the cost of private schooling and third-level fall?!
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Well, you don't know for a certainty what the future holds for your kids.

But you do know, with certainty, that you have a mortgage today.

So you are effectively creating a liquid reserve to meet an anticipated future expense before discharging a known current liability.

Would you really send your kids to a private school while defaulting on your mortgage?
 
Sarenco said:
Would you really send your kids to a private school while defaulting on your mortgage?
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You'd be surprised at the number of people who do!

PTSB have a contractual treatment of mortgage overpayment which is interesting in the context of this discussion.

Overpayments sit as a credit on the account, reducing the interest accruing balance, but don't change your maturity date / repayments. When you need money for something else, you can stop paying the mortgage, and the 'credit' starts getting used up. A little bit like an offset mortgage, except you can't draw the funds back down. Say you've mortgage payments of 1,000 per month. Overpay mortgage by 50k, and the when kids go to school reduce repayment to say 500. You'd have 8 years* of reduced mortgage repayments to free up cashflow to pay for education, and not go into arrears.

*It's not exactly 8 years, but I can't be bothered calculating interest on a Saturday!
 
Sarenco said:
Well, you don't know for a certainty what the future holds for your kids.

But you do know, with certainty, that you have a mortgage today.

So you are effectively creating a liquid reserve to meet an anticipated future expense before discharging a known current liability.

Would you really send your kids to a private school while defaulting on your mortgage?
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Absolutely not. We could still pay our mortgage even if I lost my job. And pay school/university fees using the money that was ring-fenced when time’s were good.

“Fix the roof when the sun is shining”
 
Gordon Gekko said:
Absolutely not.
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I didn't think so.

You are going to pay your mortgage regardless. The only question is whether you do so in accordance with the original contractual schedule or ahead of schedule.

For the sake of argument, if your mortgage had the feature referenced by Red above, would that change your view?
 
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