Saving enough for the projected cost of college can seem like a towering mountain to climb, especially for new parents. College costs are expected to triple from the time a child is born to when he or she is ready for school, says David Levy, editor of Edvisors Network, a planning and paying for college information source.
But by making smart decisions early, parents of young children can set themselves up to reach their college savings goals. Here are five college savings mistakes that new parents make -- and how to avoid them.
1. Letting time go by: If a parent waits until high school to start saving for college, they will need to contribute six times as much per month as a parent who starts saving from birth, Levy says.
"What people forget is the most powerful tool you have on your side when it comes to saving for any goal, is time," says Mari Adam, a certified financial planner and president of Boca Raton, Florida-based fee-only firm Adam Financial Associates Inc. Fee-only firms don't charge a commission for receiving or selling products. "If you can use the power of compounding to your advantage, and if you start now, you can save much more."
Parents can also invest more aggressively and seek a higher rate of return when a child is younger, says Matt Olver, senior vice president and wealth advisor at Cleveland-based Spero-Smith Investment Advisers Inc., also a fee-only investment management firm. That's because they have more time to weather the swings of the stock market, he says.
"In terms of the return opportunity, it's probably even better for you when that child is younger," he says.
[Take these four steps before opening a 529 plan.]
2. Succumbing to sticker shock: "They're looking at what that cost of attendance is now -- looking at what it might be 17 years from now -- and they're deciding why even start? There's no point," Levy says.
But families don't need to have a goal of paying for 100 percent of the cost of college. They can use college calculators to get a sense of how much college is expected to cost at in-state public colleges, out-of-state public colleges and private colleges, and then set a monthly savings plan based on how much they hope to fund.
"Do some thinking in advance," Adam says. "No one said you have to pay for the whole thing."
Levy recommends using the "one-third rule." Make it a goal to save enough to pay for one-third of the projected cost, and to use income, gift aid and loans to make up the other two-thirds.
Automated payments into an investment vehicle specifically earmarked for college can also be helpful in reaching a savings goal, Olver says.
"Get it out of sight and out of your account before you have the chance to spend it," he says.
[Ask these four questions before opening a 529 plan.]
3. Using the wrong investment vehicle: Some types of investments can lead to unfavorable taxation and financial aid treatment, or simply won't keep up with the rising cost of college.
For instance, earnings on custodial accounts, called UTMAs, Uniform Transfers to Minors Act, or UGMAs, Uniform Gifts to Minors Act, above a certain level are taxed at a higher parent rate, Adam says, and because they are considered assets of the student, are weighed heavily in the financial aid formula.
She recommends 529 college savings plans, which allow money to grow tax-deferred. Distributions are not taxed as long as they're used for qualified higher education expenses, and many states offer tax credits or deductions. 529 plans are also considered parent assets in the financial aid formula, which means that they are treated more favorably than assets in a student's name.
Another pitfall is using a low-return vehicle -- like a traditional savings account or certificate of deposit. Tuition inflation is historically about twice the growth rate of the consumer price index, Levy says.
[Take a quiz to determine if you're a college savings plan expert.]
"You want to pick something that matches your time horizon," Adam says. "If you've got an 18-year time horizon, pick something that is very growth-oriented."
4. Thinking a financial advisor is necessary: Some new parents may think they need an investment advisor before they start saving. That's not the case.
"You don't need an advisor," Olver says. "You don't need to pay anybody to be able to invest in a 529 plan."
529 plans can be purchased "direct-sold," and often fees are lower on these than on advisor-sold plans, Levy says.
5. Neglecting retirement: As valuable as it can be to save for college early, that doesn't mean parents should neglect their own retirement savings. They should at least be maximizing the company match on a 401(k) plan, Olver says.
"There's no way to borrow for retirement," he says. "There are ways you can pay for school."
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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