Lecturer in Economics, Alan Shipman
Open University economist, Alan Shipman, gives his observations on what parents might consider when looking at saving or investing for university education.
Should parents save or invest for university education?
Not everyone agrees that parents need to save or invest for their children’s university education, or will gain anything from doing so. As the widely respected Money Saving Expert has pointed out, some people’s best approach to today’s £9,000+/year student fees is to take the student loans on offer, and wait till they graduate before they (or their parents) start worrying about repayment. The main argument is that these loans are a relatively good deal – with lower interest rates than most other unsecured borrowing, no repayment obligation if future salary stays below £21,000, repayment obligations tied to income above that, and all outstanding debt written off after 30 years. So the amount you’d save, by accumulating money up-front and not taking all the student loan available, might be less than the amount you sacrifice by using spare money to pay for higher education rather than putting it into other long-term savings products or investments.
Saving for education
It’s true that parents and their households could lose money if they pay fees up-front (for tuition and/or maintenance) and the student’s subsequent career doesn’t create much repayment obligation. But if you expect a long career at a good salary after graduation – which is still the likely outcome of many university degrees, and the main reason people study for them – then substantial savings could be made by using up-front savings or investments to reduce the student-loans taken, or to pay them back early. [As it means savings for richer parents, the Coalition government planned to impose penalties on early repayment of loans when it raised tuition fees – but it abandoned this idea in 2012.]
Minimise the debt
The savings that students and their parents can make by minimising the debt they carry away from university have been amplified by the latest changes to the scheme. As well as allowing universities to raise fees in future years (the most expensive have already risen from £9,000 in 2016/17 to £9,250 in 2017/18), the government has opened the way for student-loan interest rates to rise faster than inflation, and frozen the threshold for starting loan repayments at £21,000 to 2020 (so that inflation will draw more students into repaying). The escalating lifetime cost of student loans for graduates whose earnings go above that threshold has been starkly spelt out by recent research from the non-partisan Intergenerational Foundation.
Among the Intergenerational Foundation’s more eye-catching illustrations, for students entering university today: “Even with earnings increasing over 30 years, a graduate on a salary of £55,000 at the end of a 30-year loan term will have paid back just over £40,000 on £33,000 borrowed and yet will still owe close to £59,000.” From a macroeconomic standpoint, these findings highlight the dysfunctional state into which the UK student loan system has sunk since the tuition fee cap was raised to £9,000 in 2010/11 from £3,250 in 2009/10. The majority of graduates, who earn well above the median but fall short of mega-salaries, will pay substantially more each year in addition to their income tax – severely compromising their ability to buy property or other assets, and constraining consumer spending – while much of their student debt will still have to be written-off after 30 years, at public expense, because so much of their repayment has gone just towards meeting the interest cost.
Saving is tricky in today’s financial climate
Given these savings from borrowing less or repaying early, it increasingly makes sense for families to try to save some money ahead of their children’s entry to university if they expect to earn a good salary after graduation. But building up a pot of money to save on fees when your children (or grandchildren) start university is very difficult in today’s financial climate, even if you’ve money to spare at the end of a typical month. Most savings products, although safe, aren’t generating a real return at present, or even protecting your money against erosion by inflation. The annual equivalent rates on the highest-yielding children’s savings accounts (for those under 18, if no withdrawals are made until that age) are still slightly above the latest UK inflation rate (2.3% in March). But most conventional savings-account and ISA rates are now lower than inflation. And inflation-beating savings rates are likely to remain hard to find in the next five years even if inflation falls back to 2% in 2019-21 as the Office for Budget Responsibility forecasts.
Stocks and Shares not always worth the risk
Stocks might not be the best investment
Financial advisers have traditionally suggested that you can expect a higher return on ‘stocks and shares’, if you’re willing to take some extra risk. But the traditional wisdom that real returns on a diversified portfolio of equities and bonds can outperform those on long-term savings hasn’t been unambiguously supported in the past 20-30 years, at least for retail investors. Paul Lewis’s recent research shows that retail investors would have done better sticking to cash than going into shares for a five-year investment anytime between end-1995 and end-2015.
Although shares on most big exchanges have staged several strong rallies since the 2008 crash, it’s too early to say whether they’ve returned to being the most inflation-proofed long term investment. Some economists have argued that the overperformance of shares in the postwar period was mainly due to an expansion of pension fund inflows that has now been arrested by slower economic growth and population ageing.
Peer to Peer’s bubble may burst
Low returns on savings and traditional investments have spurred interest in new ways of channelling households’ cash into business investment – especially ‘peer to peer’ (P2P) lending and ‘crowd-funding.’ But there are reasons to be wary of these. Their strong returns to date have been the product of exceptionally low interest rates (a tide now starting to turn, as the US leads central banks into a renewed tightening phase) and a one-off inflow into the new types of loan and equity, similar to the one that boosted stock market indices half a century ago. The risk of a P2P bubble, bursting on both sides of the Atlantic, should not be understated. There may be problems withdrawing funds when they’re wanted, from unconventional investment schemes that become illiquid, even if the underlying investments ultimately pay back.
Investing in housing
Some parents will invest in housing
With real returns on saving and retail investment so hard to find, it may be tempting for parents to try switching sides – borrowing at those low interest rates, and investing directly in an asset that might gain (or at least hold) its real value. If you’re as well-off as one former prime-ministerial family , you could even try linking the investment directly to the higher education – by buying an extra property in a university city, for use by the children if they study there, or for renting-out to other students. But for most, who can’t afford to save towards a downpayment on property as well as all those other child-related expenses (and any student debt repayments of their own), this isn’t a readily accessible route – especially given house price inflation 2009 and last year’s stamp-duty increase. And it could be a disastrous one if house prices drop.
The pressure to keep debt down is set to increase
Despite the rising cost, and the arrival of degree-level apprenticeships as a fee-free vocational alternative, a university degree will remain essential for entering and progressing an increasing number of professions. The challenge for parents and grandparents is to find a way of putting money aside so that it at least holds its value, if not generating a real return. There’s anecdotal evidence that more parents, especially when graduates themselves, are channelling funds to younger family members to help fund their studies – and that the government is building this into its calculations of what students can afford.
Parents (and grandparents) might end up regretting such generosity if their offspring graduate into a low-paid job which means they never have to pay much of their loan back, or a high-paid job that makes even the biggest loan easy to pay off. But as most graduate salaries are in between, and loan costs are set to rise, the pressure on families to keep student debts down is set to increase. The trouble is, it’s currently very hard to do this via the savings or investment route. Other approaches – such as steering children towards the local university, so they can carry on living at home and avoid accommodation cost – may be a more cost-effective option for many families; though it’s one that reinforces the emerging divide between those who can travel to a university of their choice and those who have to study from home.
Financial advice, on meeting higher-education costs or any other issue, should always be sought from professionally trained and authorised advisers. Alan Shipman writes in a personal academic capacity, not as a representative of The Open University, which does not offer investment or savings advice.
