Cost of attending college has grown exponentially. The how and why has seen lots of debate but rarely if ever does any one writer try to refute the fundamental fact that college is expensive. More often, we see this argument. “Sure college is expensive but look at it as an investment which as a tremendous ROI”, (return on investment). Actually, that is a great argument in vast majority of instances. However, as I hope to outline in this post, the approach used is often biased and does not fully consider all factors that are typically included in most business ROI models.
Whoa, you say, aren’t you a marketer. Are you getting ready to take us down a finance path? The answer is yes. Marketer or not, if the argument for a college education is based purely on the financial model, then an informed customer needs some layperson terms and definitions to explain the ROI model. It is also helpful to provide some full disclosure on types of costs, investments, and periods. Therefore, that is the approach of this post. I begin with a few definitions and explanations of concepts first. After each definition, I discuss some problems and implications with these common definitions. Then I provide some examples of the application to the college investment model after making some common sense adjustments to the current assumptions. After reviewing these examples, we can see if we reach conclusions about the viability of the college education on a purely financial basis.
I will begin with the most common cost discussed. This is what is now becoming a federal government mandate cost, cost of attendance or COA. COA has its roots in the Federal Financial Aid literature and this is a typical definition. “The COA includes tuition and fees; on-campus room and board (or a housing and food allowance for off-campus students); and allowances for books, supplies, transportation, loan fees, and, if applicable, dependent care. It can also include other expenses like an allowance for the rental or purchase of a personal computer, costs related to a disability, or costs for eligible study-abroad programs.”
This is a fine definition to help compare costs across colleges and programs. However, when used in the financial model for ROI (as it most certainly is in most cases), it violates a basic assumption of ROI models. You should only include costs or expense that would incur if you take the investment action. That assumption would exclude on-campus room and board (or a housing and food allowance for off-campus students), transportation, and dependent care. Whether a person goes to college does not determine having housing, transportation or the need for dependent care. Even the need for a personal computer seems essential across all life situations these days. However, the tuitions and fees are substantial and are a major portion of the investment. Associated with college costs, would be the student loans but only the portion of the loan as it relates to tuition and fees. Taking loans that allow for high standards in housing, transportation, or food is an issue for a different kind of blog.
An additional issue with the COA is that excludes an essential cost, opportunity cost. Opportunity costs in our ROI model would be income that is forfeit because the majority of the person’s time is spent in class and studying. At a minimum that would be 4 years of at least minimum wage in a full time job, though it could be substantially more as it would seemly likely that a recent high school graduate that earns admission to college is likely to secure more than a minimum wage job.
Finally, the ROI model discounts future earnings and costs to a present day value so all dollar values are equal. Any model should discount back to the decision point of choosing to attend college. That would mean to the first month of attendance. The period is neither to a graduation date nor to a date of acceptance. Therefore, with those assumptions in mind, we can explore some alternate scenarios. There is one other time related assumption, the length of time to pay off loans. Most federal models assume a ten-year time though research cited by US NEWS in 2014 shows an average closer to 24 year Link. Since, most interest amortization is based on 10 years and most discount models in business use 10 years, we use the 10-year assumption.
Next, it is time to build out some scenarios. This may seem boring at first but I assure you that I used the most unbiased sources I could find. I also made sure to disclose the date of the studies. College costs are changing and estimates from even a decade ago can be poor representations of current conditions. Oh and by the way, if bored with the numbers you can jump down and see the conclusions.
First, we start by noting some of the research on the returns earned from a college education. The first thing that jumps out is these returns really do depend on the degree earned. This degree earned means not only what school but also relevant is what major. These factors will add quite a bit of variation in earnings. We try to stick to using on average with a big caution that keep the college and major in mind. One very commonly cited study comes from the US Census Bureau Link (however it is from 2002) showing over 10 years the college graduate earned $195,000 more than the high school graduate or $19,500 more per year. Again not the full story as we have to factor in the opportunity cost of earning $75,600 over the four years of college, which we subtract from the 195,000. Therefore, for this scenario we will use $119,400 in additional earnings for the college graduate. The Pew Report from 2014 does not show a great deal of difference though the gap is decreasing Link. For this scenario, the gain over 10 years is $175,000 and the opportunity cost is $112,000. Therefore, we have an effective gain of $63,000.
Next, we need some estimates on cost of tuition, fees, books, and supplies. The College Board Link estimates in 2014-15 that the average tuition and fees for 4-year public institutions is $9,300 per year. Books and supplies add approximately $700 for a nice round figure of $10,000 per year. Assuming that the student borrows the 31% estimate provided by Sallie Mae in 2014 Link, and then the discounted amount of interest is added on. We have another $13,500 of college cost. Our total cost for attending college for four years is $53,500.
Now to revisit the additional earnings estimates for college graduates. Using the same discount rate on the cost of student loans, we have additional earnings of $103,725 from the 2002 census date versus the $53,500 cost of 4 years of college costs with interest on student loans. Under the Pew Report of 2014, the picture is not so positive. The discounted earnings surplus for the college degree is $54,730 versus the $53,500 cost of 4 years of college costs.
It seems clear that should earnings go up because of major or the brand of the university then the return on investment is still likely to be even better. However, using the more recent Pew numbers, should the amount of college funding by loans go up substantially and/or the cost of tuition and fees go up, then the positive return on investment is not likely to become negative. While I am a firm believer in the additional non-financial benefits of a college education (see my previous posts), the ROI financial model with significant student loans just does not seem to make a strong case at this time.