Returns to Education

Returns to a College Education

"Seven years of college down the drain."
-John Blutarsky

Mr. Blutarsky, as many will remember, offered the conclusion above to his Delta house frat brothers following their especially memorable meeting with Dean Wormer. The statement is correct. Anyone who attends college for seven years only to be expelled without a degree, and with Mr. Blutarsky's zero point zero GPA will not earn any return on their college investment. Otherwise though, expect college to pay.

Occasionally in the popular press there will be an article discussing the trials and troubles of college graduates in the market place. Someone's promising son with a BA degree in management science cannot find a job and after hundreds and hundreds of unsuccessful applications he takes a job with a gutter cleaning company. He cleans gutters. A quotation from the hang wringing parents usually includes "Our college investment was a waste. It's not like it was in the good old days."

Let’s not be too sure. Remember that graduation from college for the many who attend college right after high school implies entry into the labor force at age 22. The social security retirement age is 67 years. Congress and the country are expecting 45 years of work. One bad year does not assure ruination and a life hanging on the eves. If we can presume that a management science degree means a person with some skills and curiosity, it is quite possible that advancement to gutter crew supervisor and then perhaps gutter manager is in the future. Maybe college skills give him the ability to start a gutter cleaning firm and then a gutter cleaning franchise. Millions earned as a franchise tycoon could be the future, it is hard to tell because figuring an accurate investment return for 45 years requires knowledge of interest rates, inflation and future salaries. Past trends give some ability to know these things, but the key components can only be estimated over such a long period of time. It is better to focus on the near term, which usually gives the correct answer anyway.

There are several ways to estimate returns on investments in education, or other types of investments for that matter. The need for calculations of compound interest gives the impression that investment returns are precise and use only one procedure. However, there are different procedures, even though the actual arithmetic is always precise. Economists, for example, like to include the time in college as time away from work. If time in college is time away from work then lost or foregone wages as well as tuition payments will be a cost of college and included in calculations. Those less devoted to the economist’s way might wonder why time in college is time away from work. Many go to college and work. The time in college might come from leisure or free time instead of work. The matter is in doubt and depends partly on preference.

Despite the need for choice in computing educational return a few comparisons can give meaning and substance to the great American cry "Get some training." High school degree or GED skills are general workforce skills. Millions of America’s jobs need only on the job training and general workforce skills. If we look at wages for some of the jobs with general workforce skills and compare them to other positions requiring college degree skills we can make some easy comparisons.
Suppose a brokerage clerk earns the median wage reported for brokerage clerks, but wants to go to college to become a personal financial advisor. The median wage reported for brokerage clerks is $36,390; the median wage for personal financial advisors is $66,120. If the difference of annual income is more than a year of college tuition, expect college to pay.

Suppose a bookkeeper earns the median wage reported for bookkeepers, but wants to go to college and become an accountant. The median wage for bookkeeping is $30,560; the median wage for accountants and auditors is $54,630.
Suppose a teaching assistant earns the median wage reported for teaching assistants but wants to go to college to become a certified teacher. Teaching assistants earn a median salary of $20,740; certified public and private school teachers have a median wage of $45,000 to $47,000.

Check wages between civil engineers and civil engineering assistants, or architects and architectural and civil drafters, or physical therapists and physical therapists aides and so on. For the many jobs where annual wages jump more than a year’s tuition, compound interest calculations are not important.

Rather than comparing reported wages it is possible to convert college tuition and expenses into an estimate of a minimum wage or minimum salary increase that will make college a paying investment. The process requires interest calculations because money paid for college tuition and expenses could be used to buy stocks and bonds or other interest earning assets. Tuition and expenses amounts to an investment in a higher paying job, even though college students may want to go to college for other reasons.

Suppose in-state tuition at public college is $6,000 per year each year for four years. In some states like North Carolina, the state tuition is reported as $3,886, while in others like Michigan it is $7,115. Some are above, some below $6,000, but we let $6,000 be a representative tuition for 2007. In the first year $6,000 invested in stocks and bonds would earn interest or dividends. Similarly in the second year, except $12,000 would be invested and the second year earns interest or dividends on $12,000. At the end of four years at the time of graduation the principal invested and the interest earned is a total amount, which will equal $27,230.82 at 5 percent interest. Our thanks for the $27,230.82 total goes to the built in spreadsheet functions on MS Excel.

Suppose instead it is necessary to borrow the $6,000 each year to pay tuition. Not every one has $6,000 a year to invest in anything, much less a college education. Borrowing the money does not change the calculation unless interest rates differ between borrowing and investing. To have the college investment pay, a higher income stream from a higher paying job must be equal to, or greater than, monthly earnings on $27,230.82. If we presume the same 5 percent interest rate, then borrowing only changes $27,230.82 of equity investment into $27,230.82 of debt. Either way the college investment amount is $27,230.82 after four years.

The principal amount of $27,230.82 earning 5 percent interest over the next 10 years and compounding monthly will be equal to $44,849.42. Start at graduation and $288.82 of extra income each month over the next 10 years using 5 percent interest will also be the same $44,848.63. The $288.82 equals the minimum extra monthly earnings necessary to pay for a college education at an interest rate of 5 percent. A lower interest rate will lower the amount of necessary earnings; higher interest rate will raise the amount. Using a forty-hour week and 160 hours a month it is less than $2.00 an hour of extra wage and salary that pays for college. Experiment yourself. Use the Excel help file under FV, which stands for future value. The spreadsheet entries above are =FV(.05/12,120,0,-27230.82,1) and =FV(.05/12,120,-288.82,0,0).

The $288.82 a month could go up or down depending on a number of variables and there is some additional risk using debt to pay for college. There is a difference of risk between debt and equity financing college because there can be a delay in getting a better job. Delays leading to missed loan payments mean unpaid interest added to principal, making it quite possible to be overwhelmed with rising payments. This could be true even though a delay may not make the investment unprofitable over the long term.

Bad timing could ruin an otherwise paying investment, but even long delays getting a better job or periods of no additional earnings will probably not eliminate the financial advantage of a college degree. Maybe our management science major above waits 10 years to get a job with a raise. After 10 years he has nothing to compare against the $44,849.42 mentioned above. But suppose he lands the right job and makes extra income for the next twenty years. The $44,849.42 at 5 percent interest will be $121,660.74 after twenty more years, but extra earnings of just $295.98 a month for those same twenty years will equal $121,657.75. Any amount of additional earnings over $295.98 a month at 5 percent interest over those twenty years and college pays.

Suppose interest rates go from 5 to 10 percent in the example above where tuition was $6,000 per year. The same $6,000 per year for four years goes up to $30,975.84 from $27,230.82. The higher principal will increase much faster at 10 percent over the next 10 years and compounding monthly will be equal to $83,852.88 instead of $44,849.42. The minimum monthly wage and salary increase necessary to pay for college tuition at 10 percent over the next 10 years jumps to $409.34 per month instead of $288.82. Higher interest rates make college a less attractive investment, but millions of jobs open up to college graduates that will cover a salary increase of $409.34 a month for 10 years.

In the present circumstance of education, jobs and interest rates, the extra monthly earnings necessary to pay for college is low enough to expect college to pay. It is not a guarantee, but comparing current graduation with job growth and job openings further suggests that college graduates will earn at least the minimum salary increase to make college pay.

Baccalaureate degrees were 1.4 million for the year ending June 2005 with degrees up every year since 1994 when the baccalaureate total was 1.1 million. The Bureau of the Census, Current Population Survey reports educational attainment for adults over age 25. Those employed with a BA degree or higher are up and although the increase has been fluctuating in recent years, the increase averages 1 million to 1.1 million a year in the years leading up to 2007.

The Current Population Survey counts people employed and not specifically their jobs. It does not tell us if the increase of people with new degrees also find jobs using college degree skills, only that they are finding jobs. Other surveys of the Bureau of Labor Statistics count jobs and occupations for establishments. Establishment jobs ended the calendar year 2005 with 2.3 million more jobs than 2004, but we should expect new graduates to be looking for new jobs using their college degree skills. There is help in counting the jobs using college degree skills because the Bureau of Labor Statistics publishes a skills taxonomy that gives a clear assessment of the jobs that need college degree skills, along with those that do not. In 2004, establishment jobs with a Bureau of Labor Statistics skills classification needing a BA degree, masters, doctorate, or professional degree came to 26.4 million. The number of college degree jobs increased an average of 950 thousand for the years from 2004 to 2006, when the new total is 28.3 million.

If you are paying close attention, you noticed new degrees outnumber new jobs using college degree skills, but chances for a new job improve the more current job holders leave the workforce to retire or for other reason. People who retire need to be replaced before there can be growth. Replacing people in addition to job growth is defined by the Bureau of Labor Statistics as job openings. Openings in any occupation that has job growth will be greater than job growth. If jobs are declining, openings will be limited to replacement jobs, but otherwise openings are greater than job growth. Openings for jobs using college degree skills are forecast by BLS to increase at 1.2 million a year through 2016.

Even though college graduates are increasing faster than jobs and openings in the Bureau of Labor Statistics college degree categories, the difference is modest. However, it is not necessary to have a job using college degree skills to make college pay. Moving from a job as bookkeeper to an accountant with a college degree makes it easy to establish cause and effect for higher pay and a college degree. That is important because making college pay depends on a higher wage because of a college degree. Often it is easy to establish cause and effect like the bookkeeper who becomes an accountant, but not always.

Sometimes people with college degrees take jobs that do not need college degree skills. Employers might prefer people with college degrees even though they might be over qualified for the work. They might pay someone with a college degree more than a high school graduate in the same job. Cause and effect is hard to establish, but it would be necessary to have a college graduate in a high school job and earning no more than high school graduates if college does not pay. Making college pay is a financial matter, not a matter of job title or status. As of 2007, the financial evidence is clear enough to predict college will pay.