How Does Inflation Affect Savings For Things Like College?

A survey of parents finds that they are increasingly concerned about the impact of inflation and stock market volatility on their college savings.

Fidelity’s 2022 College Savings Indicator Study reports that four-fifths of parents (81%) are worried about the stock market, up from three-quarters (74%) two years ago. 

At the same time, concern about the Covid-19 pandemic has decreased from 71% to 62%. 

College remains the top savings priority of parents of college-bound children and they are increasing the amount they save as college costs continue to increase. Three-quarters (76%) of parents have started saving for college, up from 58% in 2007. 

But, while parents hope to save two-thirds of their child’s college costs (69%, up from 65% in 2020), they are falling short of this goal. Parents are on track to save 27% of college costs, down from 33%. This may be because a majority of parents are relying on guesses about college costs instead of actual data.

Almost a third (30%) of parents with student loans have not yet started saving for their children’s college education. 88% of parents with student loan debt plan on redirecting their student loan payments to college savings when they are done repaying their student loans. 

Impact Of Inflation On The Stock Market

Inflation rates appear to have peaked at 9.1% in June 2022. But, inflation rates are still elevated at 8.3% in August 2022. Inflation rates haven’t been this high since 1982. 

The Federal Reserve Board has been increasing interest rates by a total of 2.25% since March 2022 to try to control inflation. 

Inflation is caused by a mismatch of supply and demand. Recently, it has been triggered by supply chain problems, the war in Ukraine and the pandemic. 

Increasing interest rates increases borrowing costs, affecting credit cards, auto loans, business loans and mortgages. The Federal Reserve hopes that this will slow spending. 

But, increasing interest rates is a blunt instrument that is not narrowly targeted at the root causes of inflation. The recent increases in inflation are a global phenomenon. Also, historical data show at best a weak correlation between interest rates and inflation rates.

Yet, increasing interest rates is the primary tool available to the Federal Reserve. When your only tool is a hammer, everything looks like a nail. Or, more aptly, when your only tool is a screwdriver, investors get screwed.

Stock valuations depend in part on calculating the net present value of future revenue streams. A higher discount rate, such as higher interest rates, yields a lower valuation.

So, stock market turmoil is likely to continue for as long as the Federal Reserve continues to tinker with interest rates, probably for the next year or so. But, interest rate moves by the Federal Reserve, and the stock market’s reaction, are inherently hard to predict. 

Practical Tips For College Savers

Investors should therefore stay the course and remain invested, continuing to invest every month. According to the Fidelity study, 83% of parents are planning to increase or maintain the amount they contribute to college savings plans this year. Pulling your investment now will only lock in losses, causing you to miss out on the economic recovery. Liquidating a 529 plan may lead to a tax liability. 

Stock market volatility has less of an impact on families who chose an age-based or enrollment-date asset allocation. Such dynamic investment glide paths adjust the mix of investments periodically, reducing the percentage invested in stocks as college approaches. More than two-thirds of 529 plans are invested in age-based on enrollment-date investment options. 

These investment options bottom out at about 10% to 20% in stocks when college enrollment is imminent or when the student is already enrolled in college. This reduces the impact of a bear market or correction on college savings. During any 17-year period, there is at least one bear market and at least three corrections.

Investors can use student loans to delay taking a distribution from their 529 plans. Qualified distributions from 529 plans can be used to repay up to $10,000 each in student loans for the beneficiary and the beneficiary’s siblings. This is a lifetime limit per borrower. Parent loans can also be repaid by temporarily changing the beneficiary from the student to the parent.