Is (Your) College a Good Investment? 3 Ways To Find Out

“I just took out $50,000 in student loans, but it’s a good investment since it is for my education.”  - Anonymous Student

This is a comment that I recently overheard and it echoes a sentiment that I have heard many times before: that higher education, no matter what the cost, is a “good investment.”

Let me be clear, I strongly believe that education is one of the best investments in the world. I am very grateful to be the product of higher education as I have graduated from an Ivy League undergraduate university and then later from law school. Needless to say, I am a strong advocate of education and I believe that it is one of the best things that someone can buy.  

However, after law school, I started to invest, which caused me to analyze a lot of things, including higher education, like I would analyze an investment.       

What do I mean by analyzing higher education like an investment? What I mean is that for any investment there exists a price point where it is no longer considered a “good investment.”  For example:

• Paying $150/share today for Apple stock could be considered a good investment as that is the approximate market price today, but paying $1,000,000/share cash today would not be considered a good investment.  
• Paying $50,000, the fair market value, today for an average rental property in a good area that rents for $500/month today could be considered a good investment, but paying $5,000,000 in cash today for the same rental property would not be considered a good investment.

The reason that these examples would be considered poor investments is not because Apple stock or the rental property are worthless assets. On the contrary, they are both valuable assets. Rather, the reason that they are not considered good investments is because the price paid does not equal the benefit received. In other words, they are overpriced.    

People in the mid-2000s (myself included) learned this lesson the hard way as many people bought good assets (real estate) that were typically overpriced and with unfavorable debt. So, when the market corrected itself and the price of the assets dropped, some people found that they were not able to service the debt and some lost their property to foreclosure or filed bankruptcy. These people found out that since they bought at too high of a price, the benefit did not outweigh the cost, and they paid dearly.

Using this same logic, is there a price where higher education (both college & graduate school) is overpriced? Is it overpriced now? What about if the average cost of higher education was $500,000? $1,000,000? $10,000,000? Is that too high? With an astronomical amount of student debt outstanding, which is crippling many people financially, and many more people today deciding whether to go college/graduate school and how to pay for it, this question is as important now as it ever has been in our history.

The problem is that people are simply making this decision without knowing how to analyze whether the education that they are buying is worth the price. This is happening, in large part, because people do not know how to determine what is a good or a bad investment, regardless of whether it is for college or not. So, the goal of this writing is to give the reader some tools to analyze their own college/graduate school decision and determine for themselves whether it is a good investment or not.  

WOULD YOU RATHER….

Before we get into the higher education discussion, I am going ask a question that was posed to me by my mentor, Gary Johnston, many years ago, “Would you rather have $100 today or $1,000 twenty years from now?” (I know what you are thinking, “No one told me that there was going to be math involved!!!”  Don’t worry, the math will be minimal 😉 )

If you ask this question to 99.9% of the population, the answers would be a collection of guesses. The reason that the answers would be a collection of guesses is because the comparison is “apples to oranges” as the size and time frame of the two options are different, thereby making the decision very difficult to answer intelligently. The general population has not been equipped with the right training on how to analyze an investment, therefore they cannot boil this simple investment question down to an "apples to apples" comparison. So, they are forced to guess an answer. 

One way that investors get around this problem is by changing the “apples to oranges” to “apples to apples” which they do by boiling the comparison down to one common denominator. For example, the choice can be brought to “apples to apples” by asking if one invested $100 today, at what interest rate would that money have to grow to become $1,000 in twenty years? The answer is 11.57%. (assuming monthly compounding)

So, one way that an investor would analyze this question is by asking himself, “Can I make $100 today work harder than 11.57% over the next twenty years?” If the answer is “yes,” then that person probably should take the $100 today. If the answer is “no” then that person probably should take the $1,000 in twenty years.      

By doing this simple analysis, investors are able to take a decision that seems complicated and turn it into a simple one.    

The reason that this example matters to college is because people contemplating higher education are faced with a similar dilemma right now. They are looking at whether the huge cost of higher education paid today will be worth the higher salary that they can potentially receive down the road. However, they cannot get a clear analysis because the options are like comparing apples to oranges. (note: I know that there are many other benefits that college gives besides simply an increase in earning potential. However, the main reason that people are paying these extremely high tuitions is because they believe it will increase their earning potential.) So, if people are going to take out huge loans and justify it as a "good investment" simply because it is for their education, I think it is important that these same people know how to determine what is a "good investment" first. 

WHAT IS AN INVESTMENT?

To properly do this analysis, we have to define what is an investment. Miriam-Webster defines an “investment” as “The outlay of money usually for income or profit.” To apply this definition in a real life example, I think it is imperative to run through three essential questions before any investment.” These include:  

1. How much money is coming out of my pocket?
2. How much money is coming back into my pocket?
3. How fast is that money coming back into my pocket?

Apart from those three important question, there is a 4th question that is perhaps the most important of all, and that is….

4. If everything goes wrong, how badly will I be hurt? So, to put this into context, if one is looking a college, they may want to ask:

1. How much am I going to have to pay and/or how much debt will I have to take?
2. How much will the education increase my earnings/net income after I graduate?
3. How quickly will I get those increased earnings?
4. If things don’t go as planned (i.e., industry is in a hiring freeze, I get fired, I decide on a less lucrative career, etc.) will I be able to survive considering the cash that I spent to go to college and/or will I be able to pay back the students loans?

When those 4 questions are asked and answered, it starts to make the college decision a little bit more like an investment and a little easier to make.

ZOMBIE DEBT

We will talk about the first three questions above shortly, but first we will discuss the fourth question (i.e., what if everything goes wrong?).

An important thing to remember is that student loans are guaranteed by the U.S. government, meaning that when they are made, the U.S. government supports that the loan will be paid back. Part of this guarantee falls onto the borrower, which means that the borrower has to pay it back.

This situation is unlike most consumer debt in this country, which most people can discharge in bankruptcy. Since student loans cannot be discharged in a bankruptcy, I like to call student loans “Zombie Debt” because they CANNOT DIE!!!  

To show how this works, if an 18 years old student takes out $50,000 in student loans for college and finds out when he graduates that there are no jobs in his field, that is too bad for him. Even though the student cannot find a job to pay back the debt, the graduate is stuck with the debt until it is paid in full.

To put this in perspective, if a 50 year old man has a fun-filled weekend in Las Vegas where he racks up $50,000 in credit card bills, that person can later realize that the weekend was a mistake and that he does not have the cash to pay the debt, and he likely has the option to bankrupt out of that debt and get a fresh start.  

However, the 18 year old, who is not even old enough to drink alcohol, can commit to the same $50,000 in debt for something as noble as higher education, but if that student later finds out that the job he was expecting is not there and he cannot pay it back, then there is NO bankruptcy and that kid is stuck with that debt for life!!!  (Just digest those those two situations for a bit....)

The truth is that a huge reason that lenders can make these student loans is because they have no fear of the repercussions. What I mean is that, much like how the real estate lenders did not fear the repercussions of unqualified borrowers in the mid-2000s since they were able to get the loan off their books very fast and shift the risk to other parties, student loan lenders do not fear the repercussions of defaulting debt like other lenders because the borrower cannot escape the debt.

This inability to bankrupt out of the debt means that if the borrower defaults then the lender can garnish wages, offset tax refunds & garnish social security benefits for the rest of the borrower’s life, or until that debt is paid. What makes it worse is that when there is a default the interest of the debt is still compounding and penalties are being added to the debt, making it even more difficult for the borrower to pay the debt in full.  

So, before anyone takes on a student loan, they should review question #4 above, in particular with regards to this inability to bankrupt out, and what that would mean for them if they were not able to pay the debt.  

TIMES HAVE CHANGED

One issue today is that younger people are often advised from older generations on whether to pursue higher education. The older generations typically say that this decision to attend college is a no-brainer that should not be missed. The older generations are saying this, in large part, because it was a no-brainer when they chose to go to college. However, it is important to note that older generations did not face the same decision that kids today face as the cost of college has spiked significantly over the past 40 years.

For example, in 1971, the cost of tuition at Harvard was $2,600/year. If tuition had simply followed the normal course of inflation, it should cost approximately $15,000/year today. However, the price of tuition at Harvard is approximately $45,000!!!  Why is the cost of tuition 3 times more than it should be if it followed inflation? Is a college education 3 times better or more valuable than it was in the 1970s? Not likely. Have college graduates' starting salaries (adjusted for inflation) increased 3 times since the 1970s? Definitely not. So, potential students today cannot rely on the same logic that was used in the past as the circumstances are completely different.

Further, this extreme increase in price is important to keep in mind because…   

...IT’S NOT ONLY ABOUT INCREASING INCOME, BUT ALSO DECREASING “OUTGO”

When one hears the pitch for college and the justification of the extremely high tuition and student debt that is taken on, it is often justified with the logic that it is a good investment as it increases one’s ability to earn.

This is true, typically college graduates earn more than people without college degrees. On average college graduates earn about $20,000 more per year in starting salaries than high school graduates. However, increasing income is not the only factor, when one takes on student loans their expenses increase, which can negate any increase in income that they receive. This is similar to the person who buys a rental property that rents for $1,000/month, but costs $3,000/month to maintain. Yes, the buyer’s income increased by $1,000/month, but their expenses increased by $3,000, thereby negating any net benefit.  

That same scenario is playing out with higher education today. A graduate’s income with the college degree is likely to be larger than it would be otherwise, but the graduate is also taking on a lot more debt, which can result in lower take home pay than those individuals with only high school degrees. Below is a chart showing how this applies for college graduates who start off with a gross annual salary of $50,000 compared to a high school graduate.  (Note: The student debt we are using below is amortized over 10 years and has an interest rate of 4.25%. The tax withholdings are assuming the person lives in California and is single)

After looking at these numbers, it is important to note that the average high school graduate’s take home pay is approximately $1,926/month, nearly the same amount as a college graduate with $100,000 in debt. Although $100,000 in debt is not common for a 4 year college graduate, it is not impossible either.

While most people simply look at the increased income, the huge debt creates a significant “outgo” that people rarely consider when making the college decision. This major expenses can erase the benefit of increased income. Additionally, keep in mind, that even if one is not taking out student loans, if one is to look at college like an investment, one must consider the efficient use of their money. Meaning, is there a more efficient investment for my money than higher education?    

THE DILEMMA

As stated earlier, I believe that what makes the college decision challenging is that one is comparing “apples to oranges” and is not able to bring the analysis to one common denominator. For example, how does someone compare:

1. A high school graduate with a starting salary of $30,000  vs.
2. An in-state public college graduate who paid $80,000 and has a starting salary of $50,000 vs.
3. A private college graduate who paid $180,000 and has a starting salary of $50,000 vs.
4. A private college graduate who paid $180,000 and has a starting salary of $60,000?

As one can see, the challenge with all four of these scenarios is that all four have different up front costs and different end salaries, so it is very challenging to know which is the best “investment.” So, to overcome this we need to bring all four situations down to one common denominator, which will help to add clarity to the situation. Next, I will show you 3 ways to analyze these four groups as if they were investments and bring these numbers to one common denominator. 

HOW TO ANALYZE STUDENT LOANS LIKE AN INVESTMENT

The Criteria

Obviously, every person and situation is different and the numbers could play an infinite number of ways, but I had to make some decisions as to how I was going to make these comparisons so that I had a set numbers with which to work. The important part with these analyses is not the numbers used as every situation is different and you can input your own numbers into each analysis as you wish. Rather, what matters is the methodology. Below are the assumptions that I made along with how I got that numbers in the hyperlinks.  (Note: These analyses are focused on undergraduate options, but the same principles can be applied to graduate school as well)

Time Frame: All of these analyses are done over a span of 40 years, starting from the graduation of high school to 40 years after graduating high school.  

Groups: I created four different groups to analyze.  Obviously, there are many more types than these four, but I felt that these four groups give a good cross-section of students. I obtained the numbers from the highlighted links.    

1. High School Graduates - This group graduated high school and then went straight into the workforce without any college.  Here is the information that I used for this group:
   • Money spent on college: $0
   • Years after high school graduation when they start earning salary: 1st
   • Starting Salary: $30,000
   • Yearly Salary Increase 3%
2. In-State Public College Graduates - This group attend a 4 year in-state college  right after graduating high school.
   • Cost of College: $80,000 ($20,000/year x 4 years)
   • Student Debt: $37,000
   • Out of Pocket Costs Paid by Students/their families: $43,000 ($80,000 - $37,000) (paid $895.83/month over 4 years of college)
   • Income Earned During 4 Years of College: $0
   • Starting Salary After Graduating College: $50,000
   • Yearly Salary Increase: 3%
   • Student Loan Payments: $383.46/month ($37,000 total for 10 years at 4.5%)
3. Private College Graduate ($50,000 Starting Salary) - This group attended a 4 year private college with a starting salary of $50,000 upon graduating from college
   • Cost of College: $180,000 ($45,000/year x 4 years)
   • Student Debt: $37,000
   • Out of Pocket Costs Paid by Students/their families: $143,000 ($180,000 - $37,000) (paid as $2,979.17/month over 4 years of college)
   • Income Earned During 4 Years of College: $0
   • Starting Salary After Graduating College: $50,000
   • Yearly Salary Increase: 3%
   • Student Loan Payments: $383.46/month ($37,000 total for 10 years at 4.5%)
4. Private College Graduate ($60,0000 Starting Salary) - this Group attended a 4 year private college with a starting salary of $60,000 upon graduating from college.  
   • Cost of College: $180,000
   • Student Debt: $37,000
   • Out of Pocket Costs Paid by Students/their families: $143,000 ($180,000 - $37,000) (paid as $2,979.17/month over 4 years of college)
   • Income Earned During 4 Years of College: $0
   • Starting Salary After Graduating College: $60,000
   • Yearly Salary Increase: 3%
   • Student Loan Payments: $383.46/month ($37,000 total for 10 years at 4.5%)

Student Loan Amount:  As shown above, the student loan amount to be used is $37,000.  This is the average student loan amount of college graduates in 2016.  I used this amount for all 3 different college graduates.    

Student Loan Terms: I used a ten year term (120 months), fully amortized with an interest rate of 4.5%.  Monthly payments start the year after graduating college and are $383.46/month.  

Out of Pocket Costs: For this exercise, I had all three groups have the same amount of debt from the 4 years of college, $37,000. After the student debt, the three groups that go to college are still short the money needed. So, all of the students/their families come up with money for college out of their pocket (e.g., in state college graduates pay $43,000 and private college graduates pay $143,000) which is paid monthly during the 4 years of college.

Starting Salary: Each graduate has a set starting salary. I do not account for months out of work, laid off, underemployed, etc.  I simply make it so that the examples are earning a salary for the entire time frame as this is an “apples to apples” comparison.

Taxes: I did not account for taxes in the three analyses below, simply gross income.

Compounding: All of the interest earned in the investing discussion is compounding monthly.

Three Ways to Analyze College Costs

Investors use many different types of analyses for different types of investments. I chose three different analyses for the different scenarios presented with college. The three types are:

1. Present Value Analysis,
2. Return on Investment Analysis,
3. The “Nest Egg” Analysis (aka Future Value Analysis).  

All three analyses are simply different approaches that investors will often use when examining an investment and determining whether it is good or not.  All three will be explained later in this writing.  

Method #1: Present Value Analysis

The first analysis we will perform is the “present value” analysis. The present value is a great barometer that investors use to evaluate cash flow investments or a payment in the future. Mind you, if you are new to investing, it can appear to be a complicated concept, but just give it some time and it will make sense.  

Simply put, the present value is the amount that an investor would pay today in cash to receive either a sum of money in the future or a future cash flow stream given the specific rate of return that the investor wants for the his money. For example, If an investor was offered a cash flow stream of $100/month for the next 12 months, and the investor wanted his money to work at 15%, the investor would pay $1,107.93 in cash today to receive that cash flow stream.  

The present value evaluation is helpful in this situation because we are working to evaluate multiple cash flow streams that all have different payouts and different upfront costs. Because of all of these variables, it is virtually impossible for the human brain to compare the different situations. So, we need to use a financial calculator to figure out what is the “present value” of these various cash flow (or income streams) and the amount of money (i.e., tuition) spent to get them.

• Present Value Analysis: High School Graduate

I will start with the high school graduate.  As mentioned above, this person begins to work immediately after graduating, and the person starts off by earning $30,000/year, which I assume goes up 3% per year for the entire 40 years that we are measuring. To help explain what I mean, here is an abbreviated table showing the first 6 years and the 40th year of the salaries for a high school graduate who joins the workforce immediately after high school rather than attending college:

What the present value attempts to do is take the monthly salaries for the next 40 years, and boil it down into one number. So, here we go….

To determine the present value, we need to figure out at what interest rate at which someone wants their money to work and can make their money work. For all of these examples, I am going to use 4%, 8% and 12% as the desired returns. The reason I chose 4% is that the average person has 4% returns available to them with very little problem. I chose 8% because, while it may seem a bit high, there are also plenty of avenues where one can get that return with a little bit of education and work. Finally, I chose 12% because if someone applies themselves, studies investing, and is disciplined, 12% is very much attainable (if you are looking for quick examples of where returns of 12% and more can be found for everyday people, please click here or here or here or here or here.).

Here is the present value for the high school graduate’s salary over a 40 year span for 4%, 8%, and 12% desired returns:

After looking at these numbers, you may be wondering to yourself, “What in the heck does this mean?!!!” I hear you, and as we move along it will get easier and clearer, I promise. Anyway, these numbers represent how much in today’s dollars an investor would pay to get a 40 year cash flow stream that starts off at $30,000/year annually, and increases at 3% per year (thereby peaking at $95,011/year at year 40), if that someone wanted to get a 4%, 8% or 12% return.

So, if someone was able to get that cash flow stream for the next 40 years, and they wanted their money to work at 4% interest, they would be willing to pay $966,196.12 in cash today to get that cash flow stream in return. If they wanted their money to work at 8%, they would be willing to pay $508,344.95 today for that same cash flow stream. Finally, if that person wanted their money to work at 12%, then they would be willing to pay $318,456.32 today for that cash flow stream.

While these numbers are interesting alone, they get their true significance when compared to the present values of salaries (and costs) for someone who goes to college.  So, let’s examine the cash flow streams for college graduates.

• Present Value Analysis: In-State Public College Graduate

Now, we are going to evaluate the in-state public college graduate. The in-state public college graduate attends college for 4 years. As shown above, the 4 year total cost of tuition and room and board for this example is $20,000/year ($80,000 total).  Also, for all of these examples, we are saying that the college graduate has $37,000 in student loans. Therefore, the in-state graduate has to come up with an additional $43,000 ($80,000 - $43,000) in cash for college costs.

For all of these examples, we will have the out-of-pocket payments made monthly during the 4 years of college (e.g., $43,000 / 4 years of college / 12 months = $895.83/month.). This means that during the first four years after graduating high school, the monthly payments will be a negative $895.83/month. Then, immediately after graduating from a four year college, the graduate has to make a monthly student loan payment of $383.46/months out of his salary. Below is an abbreviated table showing the cash flow stream for the first 6 years (plus the 40th year):

Just like we did above for high school graduates, we are going to figure out the value of the cash flow stream for an in-state college graduate. As can be seen above, the in-state college graduate earns a higher salary but also has more costs (e.g., monthly costs the first 4 years and later student loan costs) which are are accounted as shown above. So, with this information we figure out the present value for an investor who is looking to buy the cash flow stream and wants his money to work at 4%, 8% & 12%.

After reviewing the above numbers, the present value for an in-state college graduate income stream is  $1,187,563.72 to someone looking for a 4% return on their money, which is approximately $220,000 more valuable than the high school graduate’s salary with the same 4% return. Additionally, for someone looking for 8%, they will pay $534,956.23, which is approximately $30,000 more than the high school graduate. However, for someone looking for a 12% return, they will only pay $274,588.93, this is approximately $40,000 LESS than the person would pay for the high school graduates salary!!!!  

This last comparison is huge and something that is extremely important to understand. Why is it that someone who wants their money to work at 12% would pay more for the high school graduate cash flow stream (starting at $30,000) than the in-state college graduate cash flow stream (starting at $50,000)?  The reasons are the simple investing principles that are discussed often in this blog: time value of money & compounding.

An investor who can make his/her money work hard (in this case at 12%) wants to get the money faster, as that person can then re-invest the money faster, thereby earning more interest faster. That high interest that is earned then compounds and grows on itself and earns more interest, and so on and so forth. For the high school graduates salary, the investor starts earning money right away and does not have to pay 4 years of college costs.

So, the investor looks at that as getting the cash immediately, which they can start investing right away, thereby getting a 4 year head start on the college graduate. Even though the in-state college graduate’s salary is higher once he starts earning income, it is not high enough to make up for the 4 lost years. However, someone who only can make their money work at 4% or 8% is not able to take as much of an advantage of the 4 year head start as they are not earning enough interest to do so, so that makes the in-state college salary more valuable than the high school graduate salary for people who earn lower interest rates.

• Present Value Analysis: Private College Graduate ($50,000 Salary)

Now, the third group that we are examining is private college graduates who have a starting salary of $50,000. Once again, this group’s salary will increase by 3% per year.  Also, for the first four years when they are in college they will not be earning a salary, rather they will be paying the college costs not covered by student loans.

The average 4 year private tuition and room and board runs about $45,000/year.  Also, for all of these examples, we are saying that the college graduate has $37,000 in student loans. Therefore, the private college graduate has to come up with an additional $143,000 in cash. For all of these examples, we will have the out of pockets college cost payments made monthly during the 4 years of college (e.g., $143,000 / 4 years of college / 12 months = $2,979,17.) This means that during the first four years after graduating high school/during college, the monthly payments will be a negative $2,979.17/month. Below is an abbreviated chart showing how the first 6 years after graduation appear along with the 40th year.

Now, we will examine the present value for these cash flow streams as we have done for both high school graduates and in-state college graduates above.

These numbers are, not surprisingly, lower than the in-state college graduate, as the salaries and timing are the same, but the tuition on the front-end is significantly higher for the private college graduate. However, what is interesting is that for someone who is looking for a return of 8% or 12%, the high school graduate's net income stream is considerably more valuable than the net income stream of the private school graduate who starts off with a salary of $50,000.

The main reason for this is because the huge upfront costs of private school are very difficult to overcome. To put this in practical terms, Imagine buying an investment that starts off with 48 straight months of losses of $2,979.17/month. To make up for these huge losses on the front end, the investment would need to have a HUGE increase on the back end, and the salary stream starting at $50,000 is not huge enough to make up for the big loss.

Someone who can make their money work at 8% or 12% is earning so much interest with the high school graduate's salary during the first four years after high school, and during this same time the private college graduate is losing a lot of money. So, by the time that the private college graduate's net income becomes positive, it is not enough to overcome the lost opportunity cost to invest. In other words, the increased salary is not enough to make up for that huge negative cost in the beginning years, thereby causing the high school graduate’s salary to be more valuable to someone who can make their money work at 8% or 12%.

However, for someone who only makes their money earn 4%, the private college with $50,000 starting salary is more valuable than the high school graduate’s net income as the 4% interest is not great enough to take advantage of the four year head start. So, the harder one can make their money work, the more they value the velocity rather than the size of the money, but for someone who cannot make their money work as hard, the size of the money is more valuable than the velocity.

• Present Value Analysis: Private College Graduate ($60,000 Salary)

Now, we will examine the final group, private college students who start off with a salary of $60,000. This group will also have their salaries increase by 3% every year. As they will be in college for the first 4 years after high school graduation, there will be no salary earned, rather, as stated above, the student will have to pay $2,979.17/month for college costs for the four years of college. Below is an abbreviated chart showing how the first 6 years after graduation appear along with the 40th year.

Now, below is a summary of the present value for private college graduates who start with a salary of $60,000, just like was previously done with the prior three groups.

As we have completed the present value analysis for all of four groups, below I have a summary of the present value of all of the groups to compare side-by-side. I have put in bold the most valuable cash flow streams for each desired return.

A few interesting points about this data are that first, the net income stream of the private college graduate with the $50,000 starting salary does not fare well at all as it only beats out the high school graduate when someone is looking for a 4% return, but for the rest of the returns this cash flow stream is dead last. The reason is that the up-front costs are so heavy and the increase in salary is not enough to make up for that lost time and money.

Next, the net income stream of the in-state college graduate is always in the middle, regardless of return on investment. It is never the highest, but it is also never the lowest of the group. It seems to be the best hedge of all of the options, regardless of one’s ability to make money work.

Finally, I think that the most interesting piece of data is that the better return that one wants/is able to get with their money, the less valuable the increased salary becomes, rather it is more important that they get their money sooner rather later. So, when someone wants/can earn a higher return with their money, then the speed that they get that money matters more than the size. When someone can only earn 4% with their money, the cash flow stream of the private college graduate with the $60,000 starting salary is most valuable, and that is because when someone cannot make money work at that high of a rate, the size of the money matters more than the speed with regards to time value of money because they are not reinvesting it at a high enough rate to earn a lot of interest.

However, when someone can make their money work at 8%, then the gap gets smaller as the in-state college is very close (approximately $30,000) behind the higher salaried private college. This is because even though the in-state college salary is lower, the upfront cost is also significantly lower, thereby somewhat negating the increased salary advantage.

Finally, when someone wants and can make their money work at 12% (once again, this is far from impossible, but it takes a little study and discipline (A few examples of how this is possible are here or here or here or here or here.), the most valuable cash flow stream is the high school graduate, followed by the in-state college graduate. The reason for this is because when someone can make their money work, the speed of the money is much more important than the size.

The cash flow stream of the high school graduate does not have 4 years of negative cash flow for tuition, rather, it gets positive income immediately upon graduating, and without student loan payments bogging them down. Since the money comes in faster, it can be reinvested faster to earn interest on it faster, and then reinvest that earned interest faster and earn interest on that, and so on and so forth…..

When someone can make their money work at a higher rate, they can earn a lot more with that “fast” money than “slow” money, thereby eclipsing the advantage of the higher salary that comes later.

Method #2: Return on Investment Analysis

The second method that we will use to examine college is the “Return on Investment Analysis” or “ROI”. ROI measures the profit generated by an investment relative to the amount of money invested. ROI is typically expressed as a percentage and is used to compare the efficiency of two or more investments.

For example, if someone presents an investor with two investment opportunities, one requires investor to pay $1,000 today and in return he will receive $100/month for the next 12 months, and the other requires him to invest $1,100 today and receive $109/month for the next 12 months, which is the more efficient investment? It is difficult to determine as both situations have different up front costs and different monthly payments, so it is a typical “apples to orange” comparison. To determine which to choose, the investor can look at both ROIs to see which is higher. The investment with $1,000 down and $100/month returns an ROI of 35% while the investment with $1,100 down and $109/month returns an ROI of 33%, meaning that the 35% investment is the more “efficient” investment of the two. While the investor can pick either investment for any reason, this gives him a common denominator to compare the two investments.

• Return on Investment Analysis: High School Graduate

For this analysis, we will not include the high school graduate. As someone who graduates from high school and immediately enters the workforce without attending college, does not “invest” any money into college as there is no upfront cost to foregoing college and entering the workplace immediately. Since they do not invest any money, it is impossible to calculate an ROI for them as the ROI calculation requires an upfront investment.  So, we will simply compare the different college graduates.

• Return on Investment Analysis: In-State Public College Graduates

When we are calculating the ROIs for all of the different college graduates, it is important to note that we are using the difference in salary to what they would have received if they went straight into the workforce out of high school. The reason for this is because they could have gotten the starting salary of $30,000/year without having spent any money on college. So, we have to see the benefit that the money invested into college gave them, and that is the difference between what they have after college and what they would have had without college. Then, we will be able to compare the different ROIs for the 3 different college scenarios.

First, we will examine the ROI for a student who attends an in-state college. Below is a chart that shows how much an in-state college graduate will pay for the 4 years of college, and how much they will earn after they graduate, minus student loan payments. It also has the comparison of how much a high school graduate earns. Then, the final column is the difference between what the college graduate paid/earned compared to the high school graduate because we are working to determine the benefit received by the college graduate.

Looking at the chart above, we see how much the in-state college graduate will pay up front in college costs, and the benefit that they will receive. Based on these numbers, the ROI over 40 years that the in-state college graduate will get is 9.1% on their investment.  Meaning that for the up front monthly costs of college, plus the lost wages that the in-state college graduate has from not working right out of high school, the return that the college graduate will get from the money invested is 9.1%.

• Return on Investment Analysis: Private College ($50,000 Starting Salary)

Just like was done above with in-state colleges, we will do a similar analysis with private colleges that have starting salaries of $50,000. Below, we have a chart which shows the data that is used for private colleges with starting salaries at $50,000. The table has the monthly income and payments made to college in the first four years, the monthly student loan payments, the amount that a high school graduate is earning at the same time, and finally the difference between those numbers as we have to see the cost/benefit that the private college graduate had from not going straight into the workforce. Below is an abbreviated table showing the first 6 years after high school graduation and the 40th year.

After analyzing the numbers above with a financial calculator, the return on investment comes out to be 6.2% over a 40 year span. This number, as expected, is considerably less than the in-state college graduate ROI (6.2% vs 9.1%) as the income is the same, but the cost for the private college is considerably higher, meaning that the ROI has to be lower because the money is being spent in a much less efficient manner when compared to the in-state college graduate.

• Return on Investment Analysis: Private College ($60,000 Starting Salary)

For the third and final ROI analysis, we will look at private colleges with a starting salary of $60,000. Just like was done above, below is an abbreviated table showing the up front costs, the salary after student debt payments, the salary they would have achieved by going straight to work out of high school and finally, the net cost/benefit received by the college graduate from going to college.

After entering the numbers above into the financial calculator, the ROI comes out to be 9.6%, and this is the highest ROI of all of the college graduates.

Below is a summary of all of the ROI analyses:

These three numbers, in and of themselves, show that if someone invests in a college education, the cash on cash ROI would be around 6% to 9%, which is not bad. However, what I found to be the most interesting part of this analysis was the comparison between the 3 different ROIs. The private college graduate with a starting salary of $60,000 has an ROI that is 3.5% higher than the private college graduate with a $50,000 starting salary, but that is only ½ point higher than the in-state public college graduate. This difference means that even though the in-state college graduate earns less, because they invest less money up-front, there money is working pretty efficiently compared to the high earning private college graduate who earns $60,000, and much more than the lower salaried private college graduate. As has been a theme throughout this blog, the focus should not only be on the benefit received once one graduates, but also on the costs to get there. Since the cost for the in-state public college graduate is considerably less than the higher salaried private college graduate, the ROI is very comparable.

Method #3: “Nest Egg” Analysis (Future Value Analysis)

This is the final analysis, where I compare the four groups by determining who will have more money, or a larger “nest egg,” 40 years after graduating high school. In this analysis, I am playing out hypothetical situation that allow one to see how the future would be when the different people reach retirement age. This situation is different than the previous examples as the previous example were more to analyze and compare the costs and salaries in a vacuum, and this analysis is meant to give the comparison a more "real life" component so that someone can see how much money they will have when they retire.

The reason for this analysis is that having a large sum of money is ultimately the reason that most people go to college. Yes, as I mentioned above, there are other many benefits (i.e., learning, maturation, social life, exposure to different people/cultures/ideas, etc), but the main main reason that people are agreeing to pay these huge fees is typically because one who goes to college will be able to get a higher paying job and ultimately have more money than someone who does not. So, one way to measure whether this improvement in salary truly results in greater wealth is by seeing who has a bigger “nest egg” after 40 years.

To do this analysis, I took 10% of the monthly gross salary of the four graduate types, and I have them invest/pay student loans with that 10%. I chose 10% because that is a number that I hear a lot of experts recommend as a good investment benchmark. So, for example, for the high school graduate, his first year salary is $30,000, $30,000/12 months = $2,500/month.  Then, 10% of $2,500 is $250. This means that, in this analysis, the high school graduate will invest $250/month the first year after graduation. Then, I show the result if that 10% of gross salary is invested at 4%, 8% and 12%.

The major difference with the high school graduates and the college graduates is that for the college graduates during the four years in college they are not investing anything, as they are not earning any money to invest. Then, when they graduate, their student loans needed to be accounted for, so I subtracted the monthly student loan payments from the 10% that is being invested because when one is paying down debt, the net effect is the same as investing.

Here is an example showing how I did this, for the first year that the in-state public college graduate is earning, they are earning $50,000/year. $50,000 divided by 12 months = $4,166.67/month, and 10% of that is $416.67/month to be put towards investing or student loans.The monthly student loans are $383.46/month, meaning that there is $33.21/month left over after paying student loans to invest for that first year after college (or 5th year after high school). Then, with the money left over, I had that invested at 4%, 8% and 12%.

One other variable that will be examined in a few of the analyses below is when someone chooses the less expensive option, but has the money for the more expensive option (i.e. chooses to skip college altogether and join the workforce despite having the cash to go to college or the person has the money to attend private college but instead attends the more affordable in-state public college.) In that situation, I have that person invest that saved money to see how much can be accumulated. So, a few of the examples below account for this additional lump sum of cash in the beginning.

• “Nest Egg” Analysis: High School Graduate (No starting Cash to Invest)

The first situation is the high school graduate who does not have any savings for college, meaning that there is no lump sum of cash to be used to get started. Rather, the high school graduate will only be able to invest 10% of his money salary, or $250 ($30,000/12 = $2,500 * 10% = $250) for their first year. Below is an abbreviated table showing the income and amount to be invested for a high school graduate.

Based on the numbers above, a high school graduate, who invests 10% of his monthly income for 40 years, will have the following amounts at the end of those 40 years:

This chart shows that a high school graduate, who invests 10% of his gross salary at 4% will have $477,288.95 in 40 years. If that person can earn 8% on his money, then he will have $1,233,926.68.  Finally, if the same person has the knowledge of investing to earn 12% on his money, then he will have a nest egg of almost $4,000,000 in 40 years, simply by investing 10% of his income.

• “Nest Egg” Analysis: In-State Public College Graduate & Private College Graduate ($50,000 Starting Salary) (No Starting Cash to Invest)

Next, I will analyze the in-state college graduate/private college graduate who starts with a salary of $50,000. As these two groups have the same salary, and this analysis focuses on salary and not up front cost, I analyzed the two together. Once again, this group I assume has nothing left in savings after spending the money to go to college. When I analyzed this group, I had to account for the monthly student loan payments so I deducted that from the 10% invested as paying out of debt is similar to investing as one is getting rid of interest that is working against them rather than gaining interest that is working for them. Below is an abbreviated table showing the monthly payments for the in-state college graduate.

Based on the numbers above, a college graduate who starts with $50,000 salary will have the following amounts in his nest egg after 40 years.

An interesting note is that none of these numbers are as high as the high school graduate. The reason is time value of money and the compounding that the time value of money allows. The high school graduate gets 4 years of a head start before the college graduate, who is in school during these 4 year, is contributing anything. Even after the college graduate starts earning, he is not able to contribute as much as the high school graduate as he is putting most of his 10% towards student loans. Because of this, the high school graduate has a 14 year head start on the college graduate.

This head start is shown to be particularly powerful when the high school graduate can earn 12% on his money ($3,778,416.67 vs $1,891,318.21 for the college graduate) as the money gets to work at a high rate for a longer period of time, which results in a huge difference in profits (nearly $2,000,000). Then, if the two can make their money work at 8%, then the difference is significant, but less than the 12% ($1,233,926.68 for high school grads vs. $885,688.95 for college grads) Finally, at 4% the difference becomes almost insignificant ($477,288.95 for high school vs. $462,714.30 for college). This shows a theme that has been running throughout this study: if you can earn high interest on your money, then it is more important to get the money faster to reinvest it rather than waiting for a larger sum later, but if you cannot make your money work hard, then the speed advantage is negated and it is better to wait for the large sum coming later.

• “Nest Egg” Analysis: Private College Graduate ($60,000 Starting Salary) (No Starting Cash to Invest)

Next, I analyzed the nest egg size of a private college graduate who is starting off with a salary of $60,000. Below is an abbreviated version of the table of the numbers that I used.

After using the numbers above, the goal is to figure out what the size of the nest egg is after 40 years to compare it with a high school graduate and a college graduate with a $50,000 starting salary.  Below are the results:

Here is a chart summarizing all of the “nest egg” numbers above, with the largest amount for each return in bold:

In each of these scenarios, the college graduate with the lower starting salary came in last regardless of interest earned. This is because it lost to the higher salaried college graduate as the timing for both was identical, but the higher salaried college graduate simply earned more money during the same time period to invest. Then, the lower salaried college graduate lost to the high school graduate because the high school graduate had nearly a 14 year head start, and that was too much to overcome.

When someone can only earn 4% on their money, the person who goes to the private school with the $60,000 starting salary has the largest nest egg of the group, by almost double. Then when the person is able to make their money work at 8% or 12%, then the high school graduate has the biggest nest egg of the group, followed by the high salaried private college graduate. If the parties earned earned 8%, then the high school graduate out gained the higher salaried private college graduate by just over $200,000, but if the parties earned 12%, then the difference was nearly $700,000.

This happens because the high school graduate gets a four year head start when the college graduate is not earning any money, and then the college graduate for the next 10 years is allotting most of the 10% to paying off student loans. This results in a 14 year head start is very difficult for the college graduates to overcome. However, the head start only really matters when someone can make their money work at a higher rate, as this 14 year head start is not significant when someone has their money work at only 4%. This example, once again, shows that when people can make their money work hard, the speed is more important than the size, but if they cannot make their money work hard, then size matters more than speed.

• "Nest Egg" Analysis: Accounting for the Money Paid for College

The three “nest egg” analyses done above are only part of the story. Remember, an investor is always looking to see what is the best way to invest their money to get the best return. This means that in our some of the examples I have to account for the money spent out of pocket to go to college ($43,000 for in-state public college & $143,000 for private college) and see what would have happened if that money was invested rather than used for higher education. So, this final analyses shows people who had extra money to invest after choosing their post-high school option as they chose a less expensive option than they could afford. Please note that the private college graduates are not included here as they maxed out the amount of money to spend on college. Instead, the following analyses are only high school and in-state public college graduates who could afford a more expensive option, but chose the less expensive option.

• “Nest Egg” Analysis: High School Graduate (Passed Up In-State College)

First, we will analyze the high school graduate who passed up in-state college. This means that the high school graduate had the funds to attend an in-state public college (for this exercise, that will be an extra $43,000 cash), and instead of spending that money on college, he invested it immediately upon graduating, along with 10% of gross income that was done above. By adding that $43,000 investment to the high school graduate’s investment above, the high school graduate ends up with the following amounts after 40 years depending on how hard he can make his money work:

The table above shows a high school graduate who starts with $43,000 to invest, and after 40 years this person will have just shy of $700,000 in their nest egg if he can make his money work at 4%. However, if this person can make money work at 8%, then he will have approximately $2,500,000 and if he can make his money work at 12%, then he will have have just shy of $9,000,000 after 40 years!!!

• “Nest Egg” Analysis: High School Graduate (Passed Up Private College)

Next, we will analyze the situation where the high school graduate had the money to pay for private college (in this case, $143,000), but he passes up private college and instead invests the $143,000 along with 10% of his gross income. This investment results in the amounts below:

These numbers are the most mind blowing of all. By simply investing the $143,000 up front along with 10% of gross income, the high school graduate will have almost $1.2 million dollars if he can make his money work at 4% over 40 years. If he can make his money work at 8%, then he will have $4.7 million.  Finally, if he can make his money work at 12%, then he will have over $20 MILLION!!!!  This is WAY MORE than the $3.1 million for the private college graduate with a starting salary of $60,000.

When I first saw this, I could not believe these numbers, $20,000,000 seemed like a crazy amount for anyone, let alone someone without the advantage of a college education. Then, I remembered that I personally know a number of people, some of whom I am fortunate to have as my mentors, who did not graduate from college (and who did not start off with $143,000 either) who have net-worths in the $20,000,000 range.

Rather than go to college, these people went right into the workforce (plumbers, carpenters, fruit vendors, house flippers, etc.) and were extremely disciplined and became educated in investing. My point here is not that skipping college is good, rather, my point is to show that one can become financially successful without having to spend a lot of money on college and obligate themselves to a lot of risky "zombie debt." One way to become financially successful is to become educated about how to make money work and be disciplined in investing. (Here is a link to a recent blog that I wrote with a number of my favorite mentors who taught me how to make money work)

• “Nest Egg” Analysis: In-State College Graduate (Passed Up Private College)

Finally, we will analyze the situation where someone has the money to go to private college, but decides to go to in-state public college instead, thereby saving $100,000. This individual takes the $100,000 and invests it along with the 10% (minus student loan payments). I have analyzed this money if invested at 4%, 8%, and 12%.  Below are the results:

Comparing this to someone who attends a private college with a starting salary of $60,000, the amount of money is much greater.  If the person can only make money work at 4%, then the difference is about $200,000 ($719,603.70 vs. $956,201.41), but if they can make it work at 8%, then the difference is approximately $2,500,000 ($988,331.55 vs. $3,313,027.50), and if the person can make their money work at 12%, then the difference is approximately $10,000,000 ($3,108,154.75 vs. $13,756,090.72), which is a huge difference. This example falls in line with the other examples as the better the person can make their money work, then they can take that $100,000 lump sum in the beginning and put it to work so that it brings back astronomical returns.

Below is a chart showing all of the results for the final “Nest Egg” analysis done above. The highest amounts for each different interest rate of return are in bold:

When examining these results, it should not be surprising that the high school graduate who had the money to attend private college but chose not to, had the biggest nest egg of the group. $143,000, invested the right way, makes a huge difference in the financial outcome as that is a ton of money earning interest and compounding over 40 years. The next highest is the in-state public college graduate who passed up private school and invested the $100,000 difference, and lastly was the high school graduates who passed up public in-state college and invested the $43,000 right away.

What is interesting of these three is that the order of finish was based entirely on the amount of money with which they started to invest, and had nothing to do with which option they chose (i.e., #1 was high school grad with $143k, #2 was in-state public college grad with $100k, and #3 was high school grad with $43k), so those who invested more in the beginning, came out with more in the end.

Of important note, all three of these people who chose the less expensive option than what they could afford, easily beat out their counterparts at the more expensive college (i.e., the high school grad who passed on college easily beat out all of the college grads and the public college grad who passed on private college easily beat out the private college graduate) So, the point here is to remember when analyzing your own college decision, it is not only about avoiding debt, but also it is to make sure that you are using your money in the most efficient manner possible.

CLOSING

I know that there is a ton of data that has been analyzed here and you may be thinking to yourself, “What does it all mean and how can I use to to make a more effective decision for college?”  Here are a few points that I think are important to remember:

• One of the most important things to realize throughout all of this data is the power of time value of money and compounding. People that understand these concepts know that they want to get their money working for them ASAP. When people are able to make their money work at a higher rate, than they can truly take advantage of time value of money and compounding and it has a huge impact on their bottom line.
• Generally, when someone can make their money work for them at a high rate, the best options were typically high school graduate or in-state college graduate. The reason for this is because the upfront costs for these two options are much lower than private college. If someone is good with money, the analyses show, that they lose a LOT by spending a significant amount up front on college, because they lose the ability to invest that money to earn interest immediately. Additionally, as high school graduates are earning income immediately, then they can invest it immediately and reap the rewards of the high interest they can earn, and the sooner that one who earns a high interest can do that, the better.
• Conversely, the figures above show that someone who cannot make money their money work at a high return ends up in a better position financially if they go to the higher salaried private college. Because if one cannot make their money work hard, then the size of the money is more important than the speed since they are never able to reinvest the money at a high enough rate of return to take advantage of the time and make up for the lost income earning.
• The one option that was at the bottom of the pile for every analysis was the private college with the lower starting salary of $50,000. This is because of the huge upfront cost is very difficult to overcome, and the salary that it gives its graduates is not enough to make up for this huge cost.
• The in-state public college was often in the middle of the road for the analyses. It was typically the best hedge regardless of how hard one can make their money work.
• If one does have money saved for college, it would be advisable to strongly consider not spending the majority of that money on the most expensive school available. Rather, it would be advisable to consider a less expensive education option so that there is still money left over to invest in hard assets (e.g., real estate) and then let that investment grow. As the numbers above show, that one action can have AMAZING financial benefits for years to come.
• Apart from the data, and as previously discussed, it is very important to keep in mind the question, “What happens if everything goes wrong?” Meaning that if one takes on a lot of debt and/or spends all of their disposable cash on higher education and can’t find work, gets laid off, changes professions, etc. then how bad will that hurt? Remember, one cannot discharge student loans (aka “Zombie Debt”) in bankruptcy, meaning that whatever one borrowers for school, one has to pay back, no matter what. This fact makes the more expensive schools a riskier investment, and that risk has to be explored. So, this question, like it is with investing, is probably the most important question of all in making the college decision.

Ultimately, in society there is an idea that the only way to make a good financial living is one needs to go to college, which often means for a lot of people, that one needs to spend their entire life savings or they need to go into a lot of debt. While it is true that going to college often gives one an increase in earning potential, it also costs a lot, and that cost needs to be analyzed against the increase in salary. These costs, as many higher education graduates have found out, can have a major negative financial impact on their lives.

The truth is that people can still have financial success without going to college or by going to a less prestigious college. However, often for these people to have financial success, they need to have 2 things: 1.Financial discipline and 2.An understanding of how finance and investing works so that they can make their money work for them. While this seems daunting, there are many financial and investing education options out there, and they are much less expensive than most higher education options. As I previously mentioned, I listed some of my favorite financial educators on my blog, to see this list, click here. These people have had a huge impact on my financial life and at a fraction of the cost of “traditional” college. Interestingly enough, I know that many people on the list did not attend college at all, let alone a very expensive one, yet that did not stop them from still attaining financial success.

In closing, I am a proponent of higher education as I think it offers a lot of value to students and it also can provide students with a more prosperous financial life than would be available otherwise. However, I also have seen many situations where the cost of higher education and student loans have far outweighed the benefit received, and these situations have led to devastating financial results for many people. I believe that a number of these crippling financial situations could have been avoided if the students had the tools to analyze the true costs and benefits of of higher education before making their decision, rather than obligating themselves to the debt simply because they were told that it was a “good investment.” I hope that this blog has given others a starting point to examine higher education costs and student loans in a more educated manner so that they can ultimately make the decision that is best for them and their future.

What do you think about these ways to analyze an investment in higher education? Do you have another method? Please share your thoughts below.