Should you invest in equities, bonds or property – or a college education?
The start of the university year has brought a new round of angst about whether a US university degree is worth the money, after years of inflation-busting fee increases, mounting student debt and disappointing job prospects for graduates.
Comparing a university degree with an investment in stocks and bonds leaves out great unquantifiable benefits of higher education, but the return on such an expensive outlay is a vital consideration for parents, children and society at large, even if it is often felt instinctively rather than spelt out or calculated.
In the US, where tuition fees have more than tripled in real terms since the 1970s, the student debt burden now sits at $1.2tn. One in seven recent borrowers defaulted on student loans within three years – a rate that suggests college has become unaffordable in too many cases. With countries including the UK moving rapidly towards a US-like model, the debate has resonance around the world.
The Federal Reserve marked the back-to-school season with a series of research pieces on the Liberty Street Economics blog of its New York branch last week, and their headline results were not nearly as gloomy as one might expect.
Statisticians Jaison Abel and Richard Deitz concluded that the real-terms value of a college education has remained close to all-time highs even as fees have soared and the Great Recession has chewed up the job market. The value of a college degree (calculated as the additional earnings power of graduates versus those without a higher education, minus fees and a loss of potential earnings during one’s college years) has hovered around $300,000 in today’s money since the turn of the millennium.
There is one main reason for this. While the political controversy focuses on tuition fees, by far the largest component of the cost of higher education is the opportunity cost of being out of the labour force for four years, and that has actually shrunk in real terms because of the declining earnings power of those without a degree. That makes sense intuitively. It is why more people decide to stay on in education or go back to college during recessions, but can often be overlooked.
In work earlier this year, Mr Abel and Mr Deitz used their models to calculate a return on investment for the average college student of 15%. It is a figure “easily surpassing the threshold for a sound investment”, they wrote. “To put these findings in perspective, consider that investing in stocks has yielded an annual return of 7% and investment in bonds an annual return of 3% since 1950.”
Even when looking at different majors, the returns look good. Engineering degrees top the league table with a return on investment of 21%, and agriculture, hospitality and education degrees come in at 9-11% at the other end.
However, this comparison of returns with the stock market is highly unsatisfactory, even on its own terms. Risk adjusted, the comparison is much less favourable. Investing in a college degree is not the same at all as buying a Vanguard S&P 500 tracker fund. It is the equivalent of putting all your money, and probably some borrowed money, too, on a single constituent of the Dow Jones Industrial Average.
A college degree may well pay off handsomely for the average student, but no one is average. An engineering student at an Ivy League school is a different proposition to an arts major from a lesser-known college, and even taking one extra year to finish one’s degree can wreck the return on investment.
Only three-quarters of graduates earn more than the average worker without a college degree, according to Mr Abel and Mr Deitz, meaning that college may be a negative investment for one in four of the people who go. Meanwhile, tracking of online job postings since the Great Recession by the Conference Board, the US business organisation, shows that openings for graduate-level jobs have stalled over the past 18 months, while demand for less-skilled workers continues to improve. This worrying trend suggests the rosy calculus for the return on investment of a degree could erode in the future.
In short, for many the return on investment of a college education will be significantly lower than the historical average, and for many it will be negative. Add in the risks of borrowing money for a gamble that has a high chance of failing to pay off and you have a very different calculus.
Except that the question of going to college is not like buying a second home or investing in stocks and bonds, not one bit of it. The friendships, the growing up, the sheer life of it all – these have to be on the table too. As university freshmen unpack their belongings, attend their first classes and forge their new relationships this month, let us hope that these financial calculations are put in their proper perspective.
Copyright The Financial Times Limited 2014