The following is a guest post about investment. If interested in submitting a guest post please read my guest post policy and then contact me.
With prices of higher education skyrocketing by about 1000% since 1976 and greatly outpacing inflation rates, many are wondering whether higher education is actually a bubble.
While college degree holders typically earn more than non-degree holders, the gap is narrowing. In addition, the crippling amount of student debt one must take on to go to college might not justify the increased earnings. The below post provides a framework for evaluating the decision to go to college along with some analysis on key considerations.
How to Evaluate an Investment Decision
Discounted Cash Flow analysis is one of the most common methodologies used to evaluate investment decisions. It is calculated as:
DCF Value = future cash flow / (1 + discount rate)^number of periods
Future cash flow in the case of a degree is the additional wages earned above that of not having a degree and net of debt repayments. In the case of, for example, buying a house as in investment, the future cash flow would be in the form of the sale price at a future date and the rental income generated.
The discount rate in the formula is the Opportunity Cost. The opportunity cost accounts for the Time Value of Money. According to the time value of money, a dollar today is worth more than a dollar tomorrow because you can earn income on it. In the case of higher education, the opportunity cost is the sum of the wages forgone while studying, and the interest that could be earned on the cost of the degree.
Let’s examine each of these factors for determining value in more detail and in the context of deciding to go to college.
The price of higher education decreases cash flow. It is either an upfront cost, or, more frequently, paid off over several years.
Supply of low interest rate student loans by government and private lenders has increased demand for higher education and a corresponding increase in price.
The price of higher education has increased by about 1,000% since 1975. Yes that’s thousand — four digits. Let’s assume a price of $30,000 per year to go to college. Some schools cost more, some cost less.
Key takeaway: Higher education is really expensive.
Many (all?) people attend college because of the added job opportunities and corresponding wages. Studies show the gap between degree holders and non-degree holders is narrowing by measures of unemployment and wages.
Intended to increase supply of educated labor, the abundance of supply of student loans at artificially low interest rates may have increased supply too far. Labor markets may have misallocated themselves to jobs requiring degrees. The resulting increased supply leads to lower prices (wages), and the decreased supply of non degree requiring price leads to higher prices (wages).
Increases in wage earnings potential may also vary from school to school. For example, from my personal perspective, it seems like graduating from Harvard still presents amazing opportunities, while a degree from the bottom 75% or so of schools seems to be a “non-differentiator” that just lumps people in to the large population of other people that have degrees.
Key takeaway: a college degree may still increase wage earning potential, but it may be decreasing and/or the opportunity cost may be increasing.
3. Opportunity Cost
The $30,000 per year could be invested in the stock market, bonds, or savings, to earn returns
The time could be used to earn wages. The time could be used to learn and otherwise acquire the value propositions that higher education offers.
Key takeaway: Higher education requires a huge investment of both time and money. The time and money could be allocated to other opportunities to generate value.
4. Asset Value
A degree has no intrinsic value. You can’t sell your degree when you’re done with it. Conversely, when you own a company’s stock, or real estate, you can sell it with some degree of ease. A degree only has value, in the form of added wage potential, because employers think it has value.
5. Forecasting Risk
If employers stop perceiving the degree to be valuable, it may not generate the forecasted increase in wages.
People may not consider the price of higher education when making the investment decision. They instead assume college is “what you do,” and pay for it regardless of price. Therefore, the price of higher education may not match it’s value, and may not be a fair value.
There may be some variances in additional earnings potential between graduates of different schools. For example, a student who graduates from an Ivy League school may be able to earn more than someone who graduates from a “mid-tier” school. Therefore, one should consider the increased earnings potential on a school by school basis, and not based on college as a whole.
Key takeaway: Lack of information may have lead to poor decision making assumptions and forecasting inputs. Poor evaluation methods and/or input assumptions may have lead to ineffective decision making and/or a divergence between a degree’s price and value.
I do not think a college education is really a good investment for a student’s financial future. The additional cash flow from college does not exceed the cost and opportunity cost. While college may still enable greater wage earnings potential, the inflation in the price of higher education has offset it.
Author Bio: Mike Fishbein is the author of Popping the Higher Education Bubble and the Founder of Startup College.