NEW YORK (CNN/Money) - For parents saving for their children's college education, the past few years have delivered a harsh lesson in economics.

The bear market has laid waste to portfolios, with the typical age-based stock and bond fund in a 529 college savings plan falling 9 percent last year, according to Morningstar.

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At the same time, school costs have skyrocketed. Tuition and fees at private colleges jumped an average of 5.8 percent last year -- far exceeding recent increases.

Public schools, which have been hard hit by state budget cutbacks, raised costs by a steep 9.6 percent.

Meanwhile, as college budget pressures have limited financial aid, student debt is soaring. A recent study by student-loan company Nellie Mae found that the average undergraduate borrower amasses $16,500 in loans, up 74 percent from 1997.

To meet this financial challenge, it's essential to have a well-crafted college savings strategy -- and the determination to stick with it.

Here's a four-point plan.

Your first step is to figure out how much you really need to save. College costs vary widely, with tuition, room and board for in-state students at public schools currently averaging $12,841 a year and annual expenses at an Ivy League school exceeding $35,000.

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Over the past two decades, college price hikes have averaged 5 percent a year, so expect future increases to exceed inflation. To see how much you'll need for a particular college, try CNN/Money's College Savings Planner.

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Chances are, the numbers that pop up will be dismayingly large. For example, to save the full cost of four years at a top liberal arts college in 2016, you would need to start saving $1,400 a month to amass $300,000.

Of course, almost no one has that much extra cash to put away. Still, you should try to save enough to get within striking distance.

What's a realistic target? "Aim to save at least one-third of the amount," says financial adviser Raymond Loewe of College Money in Marlton, N.J. "Then plan to pay one-third out of your current income and borrow the rest."

Because you are aiming for a particular goal -- one that lies no more than 18 years away -- separate your college savings from your other investments.

Despite their volatility, stocks are the only asset with the potential to beat college-tuition inflation. If you have a decade or more to save, equities should remain the cornerstone of your portfolio.

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But it's important to diversify among assets to reduce risk. Although 529s gave up an average 9 percent last year, that's far better than the 22.9 percent loss of the S&P 500; the difference was largely because of the bonds and cash held in most age-based accounts.

Still, if recent losses are costing you sleep, you may want to dial back your stock exposure. For a moderate-risk allocation, financial advisers suggest keeping 60 to 70 percent in equities if college is 10 years away, with the remainder in bonds.

Gradually trim the equity level to 25 to 35 percent by the five-year mark. At that point, shift the bulk of your assets into money-market or short-term bond funds to preserve principal.

Before you decide whether to shelter your college savings in a tax-advantaged plan like a 529, it's crucial to look ahead to financial aid -- where you invest can have a big impact on your aid eligibility.

First, keep in mind these general principles: For federal aid purposes, colleges expect parents to contribute up to 5.65 percent of assets and up to 47 percent of income (after certain allowances, such as taxes).

Your kid will be expected to chip in a hefty 35 percent of assets and up to 50 percent of income.

At www.collegeboard.com and www.finaid.com, you'll find calculators that help you gauge your eligibility under both federal rules and institutional methodology (the latter is used by colleges in granting their own money, which is typically the source of the biggest awards).

These numbers, though, are just a starting point. For parents of young children, aid predictions are highly speculative, since your financial situation will undoubtedly change.

Even for a family with a child who is just a year or two away from college, online calculators give only an estimate. The uncertainty doesn't stop there. Some private schools use stricter aid formulas.

Plus, your child may qualify for merit aid -- certain private schools are increasing grants to attract top students -- but such awards are very difficult to predict.

No one college savings option is perfect for every parent. Deciding where to invest -- in a 529, a Coverdell Education Savings Account or your own account -- hinges on considerations such as your tax bracket, your chances of getting aid and your kid's plans.

Ever-changing tax and aid rules add more wrinkles. This year's scheduled reauthorization of the Higher Education Act could change the way colleges treat 529s and other accounts; at this point, no one knows whether 529s would become more or less financial-aid-friendly.

President Bush's proposed Lifetime Savings Accounts would add yet another tax-free college savings option. (In the unlikely event that Congress enacts this plan, you would be allowed to convert your current tax-free accounts.) And the law making 529 withdrawals tax-free expires in 2010; although most experts believe it will be made permanent, nothing is certain.

To avoid boxing yourself in, you may want to invest in both taxable and tax-sheltered accounts. Here's how the three main choices compare on financial aid, tax benefits and flexibility.

Taxable accounts You can invest your college money in a regular brokerage account or fund portfolio.

Financial aid treatment: Ideal, if the assets are held in the parents' name. If you have established taxable accounts in your children's names, attorney Kaye Thomas of tax Web site Fairmark.com suggests spending that money on expenses that clearly benefit your child -- SAT prep courses or college visits. If you do so before January of his or her junior year of high school, the assets won't show up on financial aid forms, which are based on tax returns for the following year.

Taxes: The downside is the tax bill, so stick with tax-efficient funds such as index funds or so-called tax-managed funds.

Flexibility: Unlimited.

Coverdell Education Savings Accounts Formerly known as the Education IRA, the Coverdell Education Savings Account (CESA) allows families with adjusted gross incomes of up to $220,000 (married filing jointly) to save as much as $2,000 a year tax-free for school expenses.

Financial aid treatment: Poor. A CESA is considered a student asset under financial aid formulas.

Taxes: Excellent. This is one break that isn't scheduled to expire (though the cap could go down to $500).

Flexibility: Unlike with a 529, you can spend the money in a CESA on elementary and high school costs as well as college.

State 529 college savings plans With these accounts, you can save large amounts tax-free -- more than $250,000 in some states -- and often receive a state tax deduction. Investors are flocking to 529s -- assets soared to $19.2 billion last year, up from just $9.2 billion in 2001. Choosing a 529 can be daunting, however, with each state offering at least one, and in some cases several versions.

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Financial aid treatment: Dicey. Federal aid rules don't specifically address 529s but, as we noted, that could change. Right now, 529 plans are considered parental assets, which is good news. But some private colleges are already asking about 529s on aid applications, notes Kalman Chany, author of "Paying for College," particularly whether grandparents or other relatives control assets for the benefit of the student. Therefore, 529s are best suited for investors in high tax brackets (30 percent or over), who are not counting on need-based aid and can benefit most from long-term tax-free growth.

Taxes: Excellent, unless Congress fails to extend tax-free withdrawals past 2010. If so, you'd owe taxes at your kid's presumably lower rate.

Flexibility: Even though 529s keep adding investment options, you're essentially committed to a limited number of funds from one investment manager. Most 529 investors are best off with an age-based fund, which adjusts its allocation from equities to fixed income as your child grows older.

For short-term savers, another sound option is a guaranteed savings or stable-value fund, offered by a growing number of plans including New York's, Kentucky's and Missouri's, as well as Wisconsin's Edvest program; recent returns have ranged from 3.5 percent to more than 5 percent. You will probably do best to focus on direct-sold plans, which typically offer the lowest expenses. If you do choose to work with a broker, make sure he or she compares the pros and cons of several 529 plans and that you are receiving good advice for the fees you incur.