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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.
1. Price
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.
2. Wages
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.
Conclusion
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.
“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.” THIS hits the nail on the head for me.
Thanks Kasey!
Unfortunately, I have to agree with you. High school grads must assess the risk of going to college. It’s not as equitable as it was even twenty years ago. Even more unfortunate is that most parents are conditioned to want to send their kids to college and most kids believe they have to go. With less than half of Americans saving for college and even less saving properly through accounts such as an education savings account or 529 Plan and 14% of parents planning on raiding their retirement accounts to pay for their kids to go to college, many are headed for financial ruin.
Spot on John!
GREAT article and evaluation. I work in a university as an admissions coordinator, and I see so many students leaping back in to graduate studies without thinking about the actual value.
I have been thinking the same thing. There are so many trades out there in which one can make so much money without going to college. I think a trade school is probably a better option. Plumbers, electricians, hairdressers make a lot of money these days without a college degree.
You’re right Raquel. I think part of the reason those trades can make so much money is because there are fewer people pursuing them (decrease in supply). There are more people going to college and less people pursuing trades. Increase in supply of college graduates can have a negative on wages of jobs requiring degrees.
Quote: “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.”
Where do you show that the additional cash flow from college does not exceed the cost and opportunity cost? If you calculated it, by how much is the investment short?
I think there are some gross oversimplifications in the conclusion of this article that college is not a good investment. If you go to a $30k+ out of state school and study art history or religious studies, then you have virtually no shot at coming out on the winning end of that gamble financially. That is a losing proposition. If, however, you go to the in-state school and study something like engineering, not only will the in-state tuition be more like $10k per year, but in all likelihood you will earn back the difference before you even turn 35 (perhaps younger).
Great point Seth. It also depends what school you go to and what major you take.
For example, someone studying software engineering at MIT will have amazing earnings potential, while someone studying philosophy or business at the average university may not.
Note: prices of different programs/schools often aren’t proportional to earnings potential. Which it should be.
I know so many student who went to university and are crippling under the debt they have. I stay in Scotland where university is free for Scottish resident which is an absolute gift. However people in England have to pay for their tuition. Last week they said that there will still be students in their 50`s paying of student debt today. This is absolutely absurd in my opinion.
I do agree that low interest student loans and easier access to tertiary education is over saturating the market and you have young people with degrees in things they cannot find jobs in. They then end up working in coffee shops.
I think that there should be a system where the best and brightest can get free access to tertiary education.If you do not make the mark you can then pay out of your own pocket. This way they will not have too many people going to university/college and it will bring the whole system back into balance.
This is a pretty good analysis, but the key takeaway for me isn’t that college is not a good investment, but that you have to be a little pickier now. Gone are the days where you can toil away at undergrad for 6 years trying to “figure” out what you want to do. Everyone is allowed to change their minds, but if you go into college not having some idea of what your goal is, you’re wasting your time and money.
There is one thing those with student loan debt can do to increase their return on investment automatically: pay their loans off quicker. This will save thousands and thousands of dollars in interest payments and get you debt free sooner. Concentrate on paying the highest interest loan and then keep it rolling until you’re done.
I agree with the assessment if college is without specific cause i.e. your passion isn’t veterinary medicine or civil engineering. Students with little to no direction beyond “taking classes” are wasting time and money.
Agree with your assessment that individuals are much better served when they have a specific, income producing (e.g. STEM related) degree in mind.
I agree that there can be exorbitant expenses associated with attaining a college degree, I would disagree with the suggestion that a college degree is not a good investment of time/money. After all, the options for securing a well paying job (career) are fairly limited without one for most people. Is it still possible to do so without one? Sure. Let’s not fool ourselves though. Those days are nearly gone and most people will be much better served by attaining a college degree. It seems to me the real question is why do so many young people continue to saddle themselves with so much debt when it is not necessary?
My suggestions…
1. Military service. IMHO, the absolute best option. Learn a skill/trade while you are earning decent salary/benefits, use programs like Tuition Assistance (government pays 75% of costs) while on active duty, and the GI Bill once separated from service, all with the added bonus of serving your country. The savvy individual can get a college degree (multiple degrees in fact) to pair with their training and real world experience at no expense…other than the service.
2. College Savings Plan. Forward looking parents should start a college savings plan (e.g. 529) as soon as possible. Of course, the difficulty here is that financial literacy in this country is abysmal. Unfortunately, too many parents can’t figure out how to establish a $1,000 emergency fund, less known establish and effectively fund a college savings plan.
3. Community College. Why do kids have to go to a university all four years? A huge waste of money! Why not go to a local community college – closer to home (stay with mom & dad – save money) and work part-time (make money) the first two years. Overall it is a great way to spend less money and be more prepared. The first two years are primarily spent just taking core courses (e.g. English) and lower level specialty courses anyway. Moreover, when they complete the last two years at University, guess what, the degree looks the same as the person’s that spent all four years there.
At the end of the day, the problem isn’t college degrees, the problem is that too many people are financially illiterate and make poor decisions with respect to getting a college degree.
For me college is still a wise investment, it’s our ticket to find a good job, be a professional. My parents always told me before that I need to finish my studies because it’s the best investment for myself.
I think it’s a decision that needs to be thought through very carefully. It drives me nuts when I see people who go to college when they have no idea what they want to do for a career- talk about a way to end up wasting money! When I went to school I knew a lot of people who were more or less perpetual students and essentially went to college for years. Can’t imagine what their student loan balances ended up looking like.
I’ll just say this.. I got a very expensive degree from a well respected university and have probably made an average of around 15k annually the past 6 years, since graduation. My boyfriend dropped out of college after freshman year from a tiny school, we’re the same age, and he makes almost 6 figures a year as a skilled carpenter.
In the past, the answer was easy…yes go to college regardless. Now, not so much. With everyone having a degree, it levels the playing field. Additionally, the cost of college is huge. Many times it isn’t worth it to get a degree that pays $30K a year from a college that you need to shell out $200k just to get that degree. There needs to be a lot more thought and planning before making the decision to simply go to college.
There are so many low-quality jobs out there that it’s difficult to compete for any job worthwhile, i.e. a career, unless you have that college degree–that has been my personal experience as a member of the workforce in California for the past 10 years. If you go to college the cheap way, I think you can still get a great investment out of college. I went for two years at a community college, transferred to a state college for my final two years and graduated without too much student loan debt. I’m more able to get work than my non-graduate friends, at least here in California, and it’s just a different ballgame in the workforce if you have a degree vs. those who don’t have a degree. If you’re a true entrepreneur who wants to start and run a business then college probably isn’t necessary, but if that’s not your personality then I believe college is still a great financial investment and a cultural investment, as it gives us a more educated population. Plus college is a fun experience to go through for a young person, so it’s worth it (to me).
I think I’d say, “it depends”. Depends on the student, depends on the cost of attendance, depends on the student’s chosen career path, etc. etc. College and grad school were necessary for me to get the job I wanted, but that still doesn’t mean it was a good “investment”, financially speaking. That being said, it got me to the place I wanted to be, career-wise.
I agree, so many kids now are going into college because they believe that is what they are supposed to do and then spend 4 plus years trying to figure out what they are going to do rather than focusing on a single study.
College costs today are outrageous, and for many this expense is a waste of money.
I know several people who are highly successful who never finished college, and those who did say that most of the classes they paid for did not prepare them for the real world or their chosen career…
Many graduate and find that they are saddled with a mountain of debt before they can even find a job in their chosen fields. This money could be better spent in other areas that are still sound investments instead!