In recent weeks, after uncovering some frightening developments, I've been digging deep into the subject of student loans, and the so-called "College Bubble." I'll have much more to say on that in the weeks to come.
As a preview, did you know that America's student loan balance has exploded by 300% in the past five years? And that, starting this past year, student loan defaults have suddenly spiked to more than double their long-term average?
All this looking at the cost and economic load of our higher education got me thinking: just how much is a college degree really worth? From a finance nerd's perspective, that means considering the value of the investment if put toward other purposes.
To do so, first we must establish just how much a college degree is actually worth. A study by Georgetown University's Center on Education and the Workforce, The College Payoff, seems to support that million-dollar assertion. According to its data, someone who has earned a bachelor's degree will make (in 2009 dollars) $996,000 more on average over a lifetime of work.
Granted, asking the institutions themselves if college is worth it is like asking a barber if you need a haircut. But other estimates I've found, which range dramatically from $550,000 to $1.3 million, are from equally conflicted sources, such as lobbying groups like the American Institutes for Research (which lobbies on behalf of for-profit colleges, amongst others). Of all the sources I've looked at, Georgetown appears to provide the best-quality research on the subject, so we'll go with its number for our baseline.
The true worth of a college degree has to be measured in opportunity costs. How much money would you have if you skipped college and invested the money instead? A million bucks less? Not exactly. This is an exercise best suited to a prototype…
Ashley Average, born in 1995, is headed off to college along with most of her graduating class. (My fiancé asks, as she reads the draft, "Why does she have to be a woman?" Because more women go to college than men, many more.) Ashley has average grades, comes from a pretty typical dense suburb, and her family has average income and savings, making college a stretch but a possibility. So, wasn't she excited when she got into Median University, a mid-tier Division-II school known for its solidly "good enough" degree programs?
The Cost of Going Off to College
Just how much is Ashley's college education going to cost her?
Estimates for average cost of a college education vary greatly, mainly because of what the authors consider as true college costs: Just tuition? Fees? Books? Room and board? We'll settle somewhere in the middle, which, according to data from The College Board and U.S. News and World Report, is about $25,000 per year ($20,000 for public and $35,000 for private colleges, with far more students headed to public schools).
Assuming Ashley pinches her pennies, or defrays some of her costs with a part-time job, and spends only a moderate amount each year on books and supplies, plus food, rent, and other living expenses, a car, gas, etc., we'll peg her other costs at a very modest grand total of about $12,000 per year—expenses she'd have to borrow or (we'll assume for now) have paid by her parents.
If Ashley is a model student—no late-night keggers and missed morning classes for her—and manages to squeeze in one or two summer classes, she'll hopefully manage to grab her bachelor's degree in just four years (increasingly, college bachelor degree programs require classes outside the formal schedule in order to meet graduate requirements in traditional timelines), and spend just a few months finding a job. That means she'll have spent about $150,000 in the end. $100K for school, and $50K in net living expenses to make it happen.
According to Sallie Mae, a privatized quasi-governmental student loan body that serves a similar role to Fannie Mae and Freddie Mac, Ashley and her family will have to borrow about 27% of her tuition and fees, and pay about half out of pocket:
For Ms. Average and family, that means borrowing approximately $27,000 for her core expenses. For her, her parents, and grandparents, there's another $44,000 out of pocket.
If Ashley's lucky, her net living expenses, accounting for her part-time job disposing of dead test rats from the biology department, are also paid by her parents over that four-year period, and not borrowed on top of her tuition and fees. If so, then Ashley and her family will have laid out $44,000 for school, and another $50,000 for living expenses, from their savings.
Grants and scholarships will have accounted for the rest—and those don't have to be paid back, so the grand total net cost for Ashley and family is $27,000 in debt and $94,000 in cash over four years.
The net benefit to Ashley, of course, is that she will graduate with a degree, and she'll earn about $1,000,000 more in her career. Good investment? $123,000 now for $1,000,000 over time…
The Cost of Opportunity
It probably sounds good at first blush, but to truly make that assessment, we must first consider the cost of the loan. According to data from the Department of Education, the average student loan interest rate is currently 5.9%. For the sake of simplicity, we'll assume Ashley's loans were all Stafford subsidized loans that didn't accrue interest until after graduation (the taxpayer carries that float). Had they not been subsidized, then the loan balance would jump almost $3,000 by the time she graduates.
If Ashley's student loans were typical 10-year payoff periods, then her $27,000 loan would actually cost $35,800 to pay off, adding $8,800 in interest. She would have to pay $300 of her income per month to her loans, a real consideration when average graduate salaries are about $38,000 per year (that's the average across both men and women; Ashley unfortunately is likely to only make $35,300 upon graduation, while her male peers make over $42,900—but we'll conveniently ignore that social bear trap).
After payroll taxes, Ashley will be paying about 13.5% of her income to pay off that loan, leaving her with a little under $1,800 per month to live off (with optimal payroll tax deductions, and making big assumptions, like that her employer pays for her benefits or there's no state/local income tax).
If she renegotiated the loan to 20 years, as many grads do, she could free up $105 more per month to live on. But that would cost her another $10,200 in interest over the long run. For now, we'll hope Ashley isn't forced to make that call.
Then you must consider the value of the Ashley's family's savings, had it been invested instead. Had Ashley and her benefactors put the money that would've gone to college into an investment account and managed to squeeze out a conservative, steady 4% net earnings after inflation, they'd be starting off with a solid sum.
We also shouldn't neglect that while Ashley was away at MU, her productivity went into school, not into earning income. We've already assumed, had she worked instead, she would have made enough money to cover the same modest living expenses she would have incurred while in college. She would hopefully have been able to sack away a few dollars in savings during those four years, too.
For instance, if Ashley skipped college, that $300 loan payment could now go to savings. Yes, she'd be making a good deal less, but she would also be able to deduct her investments to an IRA or similar deferred account, so we'll meet in the middle and say she'd be able to put away a steady $3,000 per year for those four years she would have been in school, adding $12,000 to her starting figure.
Forgetting any subsequent investment during her career, we can take a quick swing at just how much the investment in college might have grown, had it been invested instead. Let's assume Ashley didn't put the money away until the end of those four years, that going forward she will sell 20% of her investments in taxable accounts each year, and that she'll remain in the 25% income tax bracket for a healthy 40-year career.
Under those circumstances, her college fund and the $12,000 additional savings, at 4% net interest, would yield her just over $402,000 in today's dollars by the end of her career. That, of course, comes off of a net investment of $106,000, minus a debt service of $35,000 that is now avoided. The net gain: about $330,000.
With better tax management, that total could grow by up to $100,000. Add another 1% to the performance, a more difficult task than it sounds, and we are talking $680,000 in gains instead. But even that still doesn't come close to matching the value of a college degree—even if you consider the cost of taxes.
That $1 million in salary would be taxed at an average federal rate (after deductions, credits, etc.) of 17.4%, reducing its value to $826,000 in after-tax earnings. Plus, the college degree's earnings can be spent as they are made, increasing quality of life, and opening up opportunities to save more.
Admittedly, with a $300/month debt service hanging over her head for a decade, Ashley's net earnings for most of that 10-year period after graduation will be close to what she would have made without her degree, maybe even less at first. But good things come to those who wait: in this case, much higher lifetime earnings.
$300-$600,000 invested or lost in opportunity costs vs. $1 million in salary. Still seems like college is a good idea, at least compared to going straight off to work. Had Ashley paid double for her education, however, or failed to make the average salary, it might not be so cut and dry. If she had to borrow her living expenses too, for instance, her debt service would jump to an untenable $961/month for 10 years—or if renegotiated to 20 years, add $61,000 in interest costs. At that point, the excess lifetime earnings quickly give way to the reality of current living. But for Ms. Average, at a reasonable cost, with modest borrowing, it makes financial sense to go to college.
A Bigger Upside
The average case always oversimplifies things. If Ashley were exceptionally bright, her chance at earning more would be greatly amplified with a college degree. Yes, there are those with only high school degrees who make millions of dollars per year. But looking at the stats, those in the 75th percentile of earnings with only a high school diploma earn about $1.9 million in a lifetime, over 40% more than the average. For those with a bachelor's degree, that 75th percentile jumps to $3.4 million.
In other words, a college degree expands the upside significantly. As important, it limits the downside: the 25th percentile of bachelor's degree holders still make nearly $200K more than the average high school-only grad over a career.
A bachelor's degree significantly improves an individual's chances at success. It's a gamble that our kids will be in that 75th percentile, or above—and really, who doesn't believe one's child could be? After all, being a parent is about providing your kids with the most opportunity in life. It's up to them to take full advantage of it.
Declining Marginal Value?
Lastly, before putting all the calculations to rest, it's worth considering what my broker always repeats to me: past results do not guarantee future outcomes.
These gaps in salary are based on the historical differences between those with degrees and those without—but a lot more people are headed to college these days.
Between 2000 and 2010, the number of 18- to 24-year-olds headed off to college increased 35%. Come October 2012, according to the Bureau of Labor Statistics, 66% of that year's high school graduates were enrolled in college. The National Center for Education Statistics (who knew we had a department just for that) says that total enrollment in baccalaureate programs has doubled over the last 20 years.
The net result is that America's working-age population is becoming steadily more educated. The New York Times illustrated in a recent piece just how dramatic the increases have been:
As college degrees become more common, will the value of a degree fall? Only time will tell, but the forces of supply and demand say yes. So don't be surprised if a college degree earned today accounts for a smaller average increase in earnings over time.
But, for now, Ashley is best off going to college. The same, however, cannot be said of all her peers—those who must borrow more or might spend considerably more, an easy feat with such wildly varied college costs. And, as costs continue to soar and more bachelor's degrees are handed out each year, it would be advisable for prospective students and their families to weigh the benefit against the costs more carefully, as the two are quickly moving to converge.
