Skip to content →

Tag: college

Calculating the Financial Returns to College

Despite the recent spotlight on the staggering $1.5 trillion in student debt that 44 million Americans owe in 2019, there has been surprisingly little discussion on how to measure the value of a college education relative to its rapidly growing price tag (which is the reason so many take on debt to pay for it).

(Image Credit: Dowling & Yahnke Wealth Advisors)

While it’s impossible to quantify all the intangibles of a college education, the tools of finance offers a practical, quantitative way to look at the tangible costs and benefits which can shed light on (1) whether to go to college / which college to go to, (2) whether taking on debt to pay for college is a wise choice, and (3) how best to design policies around student debt.

The below briefly walks through how finance would view the value of a college education and the soundness of taking on debt to pay for it and how it can help guide students / families thinking about applying and paying for colleges and, surprisingly, how there might actually be too little college debt and where policy should focus to address some of the issues around the burden of student debt.

The Finance View: College as an Investment

Through the lens of finance, the choice to go to college looks like an investment decision and can be evaluated in the same way that a company might evaluate investing in a new factory. Whereas a factory turns an upfront investment of construction and equipment into profits on production from the factory, the choice to go to college turns an upfront investment of cash tuition and missed salary while attending college into higher after-tax wages.

Finance has come up with different ways to measure returns for an investment, but one that is well-suited here is the internal rate of return (IRR). The IRR boils down all the aspects of an investment (i.e., timing and amount of costs vs. profits) into a single percentage that can be compared with the rates of return on another investment or with the interest rate on a loan. If an investment’s IRR is higher than the interest rate on a loan, then it makes sense to use the loan to finance the investment (i.e., borrowing at 5% to make 8%), as it suggests that, even if the debt payments are relatively onerous in the beginning, the gains from the investment will more than compensate for it.

To gauge what these returns look like, I put together a Google spreadsheet which generated the figures and charts below (this article in Investopedia explains the math in greater detail). I used publicly available data around wages (from the 2017 Current Population Survey, GoBankingRate’s starting salaries by school, and National Association of Colleges and Employer’s starting salaries by major), tax brackets (using the 2018 income tax), and costs associated with college (from College Board’s statistics [PDF] and the Harvard admissions website). To simplify the comparisons, I assumed a retirement age of 65, and that nobody gets a degree more advanced than a Bachelor’s.

To give an example: if Sally Student can get a starting salary after college in line with the average salary of an 18-24 year old Bachelor’s degree-only holder ($47,551), would have earned the average salary of an 18-24 year old high school diploma-only holder had she not gone to college ($30,696), and expects wage growth similar to what age-matched cohorts saw from 1997-2017, then the IRR of a 4-year degree at a non-profit private school if Sally pays the average net (meaning after subtracting grants and tax credits) tuition, fees, room & board ($26,740/yr in 2017, or a 4-year cost of ~$106,960), the IRR of that investment in college would be 8.1%.

How to Benchmark Rates of Return

Is that a good or a bad return? Well, in my opinion, 8.1% is pretty good. Its much higher than what you’d expect from a typical savings account (~0.1%) or a CD or a Treasury Bond (as of this writing), and is also meaningfully higher than the 5.05% rate charged for federal subsidized loans for 2018-2019 school year — this means borrowing to pay for college would be a sensible choice. That being said, its not higher than the stock market (the S&P500 90-year total return is ~9.8%) or the 20% that you’d need to get into the top quartile of Venture Capital/Private Equity funds [PDF].

What Drives Better / Worse Rates of Return

Playing out different scenarios shows which factors are important in determining returns. An obvious factor is the cost of college:

T&F: Tuition & Fees; TFR&B: Tuition, Fees, Room & Board
List: Average List Price; Net: Average List Price Less Grants and Tax Benefits
Blue: In-State Public; Green: Private Non-Profit; Red: Harvard

As evident from the chart, there is huge difference between the rate of return Sally would get if she landed the same job but instead attended an in-state public school, did not have to pay for room & board, and got a typical level of financial aid (a stock-market-beating IRR of 11.1%) versus the world where she had to pay full list price at Harvard (IRR of 5.3%). In one case, attending college is a fantastic investment and Sally borrowing money to pay for it makes great sense (investors everywhere would love to borrow at ~5% and get ~11%). In the other, the decision to attend college is less straightforward (financially), and it would be very risky for Sally to borrow money at anything near subsidized rates to pay for it.

Some other trends jump out from the chart. Attending an in-state public university improves returns for the average college wage-earner by 1-2% compared with attending private universities (comparing the blue and green bars). Getting an average amount of financial aid (paying net vs list) also seems to improve returns by 0.7-1% for public schools and 2% for private.

As with college costs, the returns also understandably vary by starting salary:

There is a night and day difference between the returns Sally would see making $40K per year (~$10K more than an average high school diploma holder) versus if she made what the average Caltech graduate does post-graduation (4.6% vs 17.9%), let alone if she were to start with a six-figure salary (IRR of over 21%). If Sally is making six figures, she would be making better returns than the vast majority of venture capital firms, but if she were starting at $40K/yr, her rate of return would be lower than the interest rate on subsidized student loans, making borrowing for school financially unsound.

Time spent in college also has a big impact on returns:

Graduating sooner not only reduces the amount of foregone wages, it also means earning higher wages sooner and for more years. As a result, if Sally graduates in two years while still paying for four years worth of education costs, she would experience a higher return (12.6%) than if she were to graduate in three years and save one year worth of costs (11.1%)! Similarly, if Sally were to finish school in five years instead of four, this would lower her returns (6.3% if still only paying for four years, 5.8% if adding an extra year’s worth of costs). The result is that an extra / less year spent in college is a ~2% hit / boost to returns!

Finally, how quickly a college graduate’s wages grow relative to a high school diploma holder’s also has a significant impact on the returns to a college education:

Census/BLS data suggests that, between 1997 and 2017, wages of bachelor’s degree holders grew faster on an annualized basis by ~0.7% per year than for those with only a high school diploma (6.7% vs 5.8% until age 35, 4.0% vs 3.3% for ages 35-55, both sets of wage growth appear to taper off after 55).

The numbers show that if Sally’s future wages grew at the same rate as the wages of those with only a high school diploma, her rate of return drops to 5.3% (just barely above the subsidized loan rate). On the other hand, if Sally’s wages end up growing 1% faster until age 55 than they did for similar aged cohorts from 1997-2017, her rate of return jumps to a stock-market-beating 10.3%.

Lessons for Students / Families

What do all the charts and formulas tell a student / family considering college and the options for paying for it?

First, college can be an amazing investment, well worth taking on student debt and the effort to earn grants and scholarships. While there is well-founded concern about the impact that debt load and debt payments can have on new graduates, in many cases, the financial decision to borrow is a good one. Below is a sensitivity table laying out the rates of return across a wide range of starting salaries (the rows in the table) and costs of college (the columns in the table) and color codes how the resulting rates of return compare with the cost of borrowing and with returns in the stock market (red: risky to borrow at subsidized rates; white: does make sense to borrow at subsidized rates but it’s sensible to be mindful of the amount of debt / rates; green: returns are better than the stock market).

Except for graduates with well below average starting salaries (less than or equal to $40,000/yr), most of the cells are white or green. At the average starting salary, except for those without financial aid attending a private school, the returns are generally better than subsidized student loan rates. For those attending public schools with financial aid, the returns are better than what you’d expect from the stock market.

Secondly, there are ways to push returns to a college education higher. They involve effort and sometimes painful tradeoffs but, financially, they are well worth considering. Students / families choosing where to apply or where to go should keep in mind costs, average starting salaries, quality of career services, and availability of financial aid / scholarships / grants, as all of these factors will have a sizable impact on returns. After enrollment, student choices / actions can also have a meaningful impact: graduating in fewer semesters/quarters, taking advantage of career resources to research and network into higher starting salary jobs, applying for scholarships and grants, and, where possible, going for a 4th/5th year masters degree can all help students earn higher returns to help pay off any debt they take on.

Lastly, use the spreadsheet*! The figures and charts above are for a very specific set of scenarios and don’t factor in any particular individual’s circumstances or career trajectory, nor is it very intelligent about selecting what the most likely alternative to a college degree would be. These are all factors that are important to consider and may dramatically change the answer.

*To use the Google Sheet, you must be logged into a Google account; use the “Make a Copy” command in the File menu to save a version to your Google Drive and edit the tan cells with red numbers in them to whatever best matches your situation and see the impact on the yellow highlighted cells for IRR and the age when investment pays off

Implications for Policy on Student Debt

Given the growing concerns around student debt and rising tuitions, I went into this exercise expecting to find that the rates of return across the board would be mediocre for all but the highest earners. I was (pleasantly) surprised to discover that a college graduate earning an average starting salary would be able to achieve a rate of return well above federal loan rates even at a private (non-profit) university.

While the rate of return is not a perfect indicator of loan affordability (as it doesn’t account for how onerous the payments are compared to early salaries), the fact that the rates of return are so high is a sign that, contrary to popular opinion, there may actually be too little student debt rather than too much, and that the right policy goal may actually be to find ways to encourage the public and private sector to make more loans to more prospective students.

As for concerns around affordability, while proposals to cancel all student debt plays well to younger voters, the fact that many graduates are enjoying very high returns suggests that such a blanket policy is likely unnecessary, anti-progressive (after all, why should the government zero out the costs on high-return investments for the soon-to-be upper and upper-middle-classes), and fails to address the root cause of the issue (mainly that there shouldn’t be institutions granting degrees that fail to be good financial investments). Instead, a more effective approach might be:

  • Require all institutions to publish basic statistics (i.e. on costs, availability of scholarships/grants, starting salaries by degree/major, time to graduation, etc.) to help students better understand their own financial equation
  • Hold educational institutions accountable when too many students graduate with unaffordable loan burdens/payments (i.e. as a fraction of salary they earn and/or fraction of students who default on loans) and require them to make improvements to continue to qualify for federally subsidized loans
  • Making it easier for students to discharge student debt upon bankruptcy and increasing government oversight of collectors / borrower rights to prevent abuse
  • Government-supported loan modifications (deferrals, term changes, rate modifications, etc.) where short-term affordability is an issue (but long-term returns story looks good); loan cancellation in cases where debt load is unsustainable in the long-term (where long-term returns are not keeping up) or where debt was used for an institution that is now being denied new loans due to unaffordability
  • Making the path to public service loan forgiveness (where graduates who spend 10 years working for non-profits and who have never missed an interest payment get their student loans forgiven) clearer and addressing some of the issues which have led to 99% of applications to date being rejected

Special thanks Sophia Wang, Kathy Chen, and Dennis Coyle for reading an earlier version of this and sharing helpful comments!

Leave a Comment

A Cure for Diabetes

(Bear with me a bit, I promise I do get to the title eventually) One of the most formative classes I took in college was a class taught by Professor Doug Melton on stem cells. While truth be told, I’ve forgotten most of what I used to know about the growth factors and specifics of how stem cells work, the class left me with two powerful ideas.

The first is that true understanding requires you to overcome your own intellectual laziness. Its not enough to just take what a so-called expert says at face value — you should question her assumptions, her evidence, her interpretation, her controls (or lack thereof), and only after questioning these things can you properly make up your own mind. While I can’t say I’ve lived up to that challenge to the fullest extent, its been a helpful guide in my coursework and in my career as a consultant, then investor, and now entrepreneur.

The second was about the importance of personal passion as a motivating force. Professor Melton’s research and expertise into stem cells was driven in no small part by the desire to find a cure for diabetes, a condition which one of his kids suffers from. It was something which made him (and his lab) work harder at finding a way to take on the daunting task of taking stem cells and turning them into the beta islet cells in the pancreas that produce insulin. It made him advocate for the creation of the Harvard Stem Cell Institute and to strongly vocalize his opinions on legitimizing stem cell research (something which I had the pleasure of interviewing him on when I worked with Nextgen).

And, its paid off! Very recently, Melton’s lab published a paper in the journal Cell which claims to have devised a way to take stem cells and turn them into functioning beta islet cells capable of secreting insulin into the bloodstreams of diabetic mice that they’re transplanted in and reduce the high blood sugar levels that are a hallmark of the disease! While I have yet to read the paper (something I’ll try to get around to eventually) and this is still a ways off from a human therapy, its amazing to see the lab achieve this goal which seemed so challenging back when I was in college (not to mention, years earlier, when Melton first wanted to tackle the problem!)

Having met various members of the Melton lab (as well as the man himself), I can’t say how happy I am for the team and how great it is that we’ve made such a breakthrough in the fight against diabetes.

Leave a Comment

Bad Defense of the English Major in New York Times

This past Sunday, the New York Times posted an editorial by a writing teacher lamenting the decline of the English major in today’s universities:

The teaching of the humanities has fallen on hard times… Undergraduates will tell you that they’re under pressure — from their parents, from the burden of debt they incur, from society at large — to choose majors they believe will lead as directly as possible to good jobs. Too often, that means skipping the humanities…

In 1991, 165 students graduated from Yale with a B.A. in English literature. By 2012, that number was 62. In 1991, the top two majors at Yale were history and English. In 2013, they were economics and political science.

The writer believes that one result of this decline is that students (and hence graduates) are now less effective at writing clearly and are losing the “rational grace and energy in your conversation with the world around you” which accompanies an appreciation of and familiarity with great literature.

While the title of this post may suggest otherwise, I don’t disagree with the writer on the value of writing and literature. On a personal level, it was only after I left college that I began to appreciate the perspective on life that the (sadly) limited literature I am familiar with afforded me. On a more practical level, I’ve also witnessed firsthand otherwise intelligent individuals struggle in achieving their professional goals as a result of poor writing and communication skills.

However, what jumped out to me about the editorial was less the message on the intrinsic value of English or the writer’s thoughtful criticisms of how humanities courses are taught today, but more how the writer effectively brushed aside the underlying financial reasons pushing students away from declaring English (or another humanity) as a major. Its easy for the writer to argue that “a rich sense of the possibilities of language, literary and otherwise” as an answer to the question of “what is an English major good for?” But that sort of sense, while personally valuable, doesn’t pay off student loans. Its easy to criticize the “new and narrowing vocational emphasis in the way students and their parents think about what to study in college”, but it doesn’t account for the little choice that parents and students have in the matter when trying to make their checkbooks balance.

And therein lies the weakness of most impassioned pleas for students to pursue English majors and humanities instead of “more practical” majors: we don’t live in the world of the below For Lack of a Better Comic:

Comic #35

We live in a world where, sadly, students need to find jobs that can cover their debts. And the pragmatic reaction for the humanities educator is to either find a way to make their majors better suited to helping students find and compete for jobs that can cover their financial burdens or find new ways to enrich students who have chosen to pursue the “narrow vocational emphasis” they have been forced to.

Leave a Comment

Advice for Entering College Freshmen

As it’s currently high school graduation season, I’ve been asked by a few friends (who have younger siblings about to graduate) about the advice I’d give to new high school graduates about to become college freshman. While I defer to (older :-D) folks like Guy Kawasaki and Charles Wheelan for some of the deeper insights about how to live one’s life, there is one distinct line of thought that I left with my friends’ siblings and that I wanted to share with all new high school grads/entering college freshmen:

Like with most truths about life, this will seem contradictory. First, take classes seriously. I know its not the sexiest bit of advice, but hear me out: college is one of the last places where you will be surrounded by scholars (both faculty and students) and where your one job in life is to learn how to think. Take advantage of that while it lasts, and make every effort to push your mental horizons. Second, and here’s the contradictory part: don’t take your classes TOO seriously. While I don’t mean its a good thing to fail, I’d encourage new students to never be afraid of skipping a class or a homework assignment if it means finding time for a friend or making time for a great opportunity. College is more about the friends you make and the things you learn outside of the classroom than the time you spend in/on it — and that’s why at the end, I wish I had both taken my classes more seriously and less seriously — in different ways.

I hope this is helpful and congratulations to the class of 2012!

PS: I’d be remiss if I also didn’t mention the post I did a few months ago on general career advice for students 🙂

2 Comments

American Politics’ Obsession with College

A few months ago, Republican presidential hopeful Rick Santorum attacked Barack Obama’s stated desire to have more Americans pursue higher education. Santorum’s reasons for doing this were fundamentally political: he wanted to portray Obama as a snobby liberal against the image he was hoping to convey of himself as a down-to-earth practical guy who doesn’t want to see money wasted on liberal indoctrination (or whatever it is Santorum thinks happens in colleges…)

While I’m no fan of Santorum’s hypocritical intentions there (anyone else notice how he neglected to mention his own college degree – let alone his MBA and JD?), I do think its worth considering the skeptical view towards American politics’ fixation (dare I say obsession?) with driving up college attendance.

shutterstock_50212558300x450This skeptical view is basically encapsulated in a single question: if the goal is to  get more Americans to go to college, why don’t we just make high school last eight years rather than four?

If we were to somehow able to achieve 100% (or even something like 60-70%) college admissions, an extended high school education (where the last four years might be more advanced and based on applications to different institutions) is basically what you would be creating.

If we think of getting the majority of kids into college in that sense, it begs the question: What would a world like that look like? I’d hazard the following two guesses:

  • First, the costs would be enormous. Even today, with many colleges being independent of the government and with many students bearing the brunt of the cost of college directly, there is huge government involvement with financing. An “eight year high school system”, even if we assumed miraculous levels of efficiency and public-private partnership never before seen in the education system and government, would likely require a huge amount of dollars spent by the taxpayer and by students – if only to provide the financial support lower-income families would need to attend higher education.
  • Second, I believe you would see the number of people going into advanced degrees (Masters, PhD’s, MBA’s, JD’s, MD’s, MPH’s, etc) would skyrocket. The reason for that is simple: if everyone goes to college – then its the same as if nobody went to college: the mark of attending college ceases to have any value in setting yourself apart from other people in the eyes of an employer. The funny thing is – one of the reasons I chose the “eight year high school” analogy is precisely because of the analogy that results: that college grads would became the equivalent of today’s high school grads: in the same trouble in terms of competing in the workforce and finding themselves needing to go to “college” (in this case getting an advanced degree).

One might even argue that a much more educated workforce is worth the cost but what this little thought experiment shows is that just extending high school by four years (the logical equivalent of getting much higher rates of college admissions) is not the obvious universal good that most politicians seem to suggest it is. The fact that students need to go to college at all to participate effectively in the workforce, in my opinion, says more about the lack of effectiveness of our K-12 system than about the value of college.

I think a more meaningful (and hopefully time-and-cost-effective) solution to our education system’s woes would actually be to address the real problems: (1) how students seem to not get enough out of K-12 to contribute to the workforce and (2) how students are forced to pursue expensive degrees just to compete.

  1. Bring K-12 quality up to what is needed for people to succeed in today’s workforce. I think this means investing in early education – study after study shows that some of the most effective education investments are those made in pre-kindergarten Head Start programs – embracing new technology-enabled approaches like Sal Khan’s brilliant Khan Academy, changing how we train and compensate teachers, and doubling down on training employable skills (like some of the ones I mentioned here). None of these are that controversial (although the devil is in the details) – what matters is being committed to the notion of increasing the value of K-12 rather than the just the years kids spend in school.
  2. Build an actually meaningful system of educational accreditation. Today, one of the most important ways to signal to employers that you can be a decent worker is a piece of paper that costs some $100,000+ called a college diploma. That piece of paper is not only extremely expensive, it also does a terrible job of elaborating what a person is good at (forcing many people to pursue further degrees). This system of accreditation really only serves colleges and the companies/people who make money off of them (i.e., admissions counselors/prep services, etc). An accreditation system which actually meaningfully communicated what people’s talents were (i.e. this person is extremely good at math, even though he did not major in math at a top 50 college; or this person is really good at machinework, even though she spent most of her last job planning events, etc) would be beneficial for both employers — who now have a better sense of who they are hiring — and workers — who can now be more discriminating about the value of their education and not needlessly participate in the rat race of tallying up schools/programs which only serve as a rubber stamp on your ability to pay expensive tuition.
These are not quick-and-easy fixes: they are after all major changes to how people/politicians view the world and require not only resources but some very slow-moving institutions to change how they think and operate, but it makes a lot more sense to me than continuing a dogma about how education should work, rather than taking a hard look at some of underlying issues.

(Image credit – SFGate/The Mommy Files)

8 Comments

Some Career Advice for Students

Many students trying to pick classes/majors in college will end up consulting with their counselors/academic advisors who, in turn, will almost always reply with very generic advice along the lines of: “study what you love”.

But as my girlfriend once pointed out, the problem with asking academic advisors that question is that academic advisors tend to be academics – and in academia, you can make a career out of studying anything. Outside of academia, that is not so true. Look no further than the paradox of how we have record high unemployment for recent college graduates despite almost every startup I’ve spoken with expressing concerns about finding and retaining qualified employees?

Obviously, our education system is failing to meet the needs of our students and employers. But, other than hope that the system miraculously fixes itself, my advice to students is this: take classes that teach broadly employable skills. You don’t need to take a lot of them, and nobody’s asking you to major in a something that you don’t want to – college is, after all, about broadening your horizons and studying what interests you. But, in a competitive job market and a turbulent economy, the worker that is in the best position is the worker who can move between industries/jobs easily (getting out of bad jobs/industries and moving into better paid/more interesting ones) and who can quickly demonstrate value to their boss (so as to make them indispensable faster).

So what sort of skills am I referring to? Off the top of my head (I’m sure there are others), three come to mind:

  • Accounting – All organizations that deal with money need people with accounting chops. From my experience, the executives/employees who are the most versatile across industries are the CFOs — they can plug into almost any business or organization and can quickly help their employers out. You may not want to be an accountant, but in a pinch, having those skills can help you get hired or find work as you figure out your next move.
  • Programming – Programming as a skill is relatively generalizable. While I wouldn’t necessarily get an iPhone developer to write an operating system (or vice versa), folks with programming chops can quickly get up to speed on new projects at new companies, and, as a result, can quickly crank out functioning code to help with their employers.
  • Statistics – You don’t need to be a math genius to be hireable. But, as computers become faster and more important, more organizations are turning to number crunching as a way to stay competitive. Not only will “data scientists” and statisticians become more in demand, individuals who have familiarity with those tools will be in a better position at their companies and be able to quickly help out a new employer.

The skeptic will point out that a lot of this can be outsourced. And, that’s certainly true – but in my experience, there is not only a limit on what companies are willing to outsource, there is also just huge value for any employee to tack those skills onto what they are already doing. A salesperson who is also good at crunching statistics on who to sell to next is far more valuable than a “regular” salesperson. A marketing guy with programming chops probably has a better understanding of a product or a technology than a “regular” marketing guy. And, a operations guy who also understands the nitty gritty financial details is going to be able to do a better job than an operations guy who doesn’t. Not to mention: the skills are broadly applicable; so if one company doesn’t have a good spot, there’s always another organization somewhere that will.

5 Comments