Everyone knows that College costs have been skyrocketing over the last 30 years. The College Board reports a 213 percent increase in public college tuition rates and a 129 percent increase in private college rates from 1988 to 2018.[i]
For many Gen Xers like myself (people born between the mid-1960s to the early 1980s), going to a 4-year college was a no brainer. College was worth it no matter the cost. A college degree was the answer to a higher paying job and a better life.
Nowadays, a college degree doesn’t necessarily mean a higher paying job or a better life. While studies by labor economists do show a correlation between education and income, paying a premium for education does not.[ii] Wages have increased in the last 20 years, but wages have not kept pace with rising tuition costs, causing that once guaranteed outsized return on your investment to shrink.
While it’s impossible to precisely predict the return on your college investment (ROI), having an awareness of the general expected return is important in making a decision that will have a huge impact on your long-term financial success.
Calculating the Back-of-the-Envelope ROI of Higher Education
Have you ever wondered what the return is on your higher education? Whether you have an Associate’s, Bachelor’s, Master’s, or Doctoral degrees, most people expect that the more expensive the education, the higher salary you should experience throughout your lifetime. In theory, this makes all the sense in the world, but is it always the case?
As I mentioned, it’s not realistic to try and calculate the precise ROI. It is, however, a useful exercise to gauge or benchmark whether or not you’re paying too much for education. You can calculate the ROI of higher education by finding out the lifetime earning that is possible as a result of education. Estimate your lifetime earnings, then divide by the total cost of education to yield a simple ROI.
For example, if you or your child wants to be a teacher and the starting salary is $35,000, start projecting out the income for every year up until retirement, say 30 years. Keeping in mind that the salary should increase by two to three percent per year.
Then take the lifetime earnings and divide it by the total cost of education. This resulting number yields the percentage return of education.
In this example, the lifetime income for a teacher is roughly $1.42MM. Divide this number by the total out pocket cost of college, estimated at $160,000 for 4 years, and the total return in this scenario is 887 percent. Is that a good return? According to a recent ranking by Bestcolleges.com that 887 would just barely crack the top 50. The #1 school, SUNY Maritime, has an ROI of 1714 percent!
How to Use Your Knowledge of ROI of Education
Let’s say you could increase the return on your education not buy making more, but by cutting the cost of your education. By going to a similarly rated school for a cost of say $80,000 instead of $160,000 makes complete sense if you are still likely to find employment at the same income level over the course of your career. Is this a valuable conversation to have with your kids who are looking at colleges? Is this a worthwhile consideration if you are considering graduate school? Absolutely!
To pay off that extra $80,000, in say 15 years at 6%, is a payment of $675 a month. Don’t forget the interest over the course of the loan of $41,515 which brings the total cost to $121,515!
So How Much Should You Spend on Higher Education?
Clients ask this question all the time: How much should we spend on our children’s education? Start with the income and work backward. When you have a clear and realistic picture of the income a career will produce, you’re able to make a more informed decision about how much money is wise to spend on education – including student loans and interest to be paid on those loans.
Figure Out That First Year’s Salary
The first year’s salary is a significant number. Payscale.com is a good place to find out how much money certain careers yield in the first year, taking into account education level, skills, and geographic location. And when you look at the bell curve of income levels, your best bet is to look at the conservative projections.
The rule of thumb today is that student loans shouldn’t generally exceed the first year’s salary after graduation. I say generally because certain professions like doctors and lawyers require more education upfront before any income is earned in those professions. In these instances, review the lifetime earning calculation above.
The first year salary minus education debt should result in a positive number.
To continue using the teacher example from above, the median annual salary according to the Bureau of Labor Statistics was $58,390 in 2017. The lowest 10 percent earned less than $37,340, which tends to comprise of first-year and part-time positions.[iii] Therefore, according to the rule of thumb, it wouldn’t make sense to graduate with $50,000 in student loan debt to be an elementary school teacher.
Why the ROI of Education Matters to Your Financial Success
What you spend on education has a lifelong impact on your financial future. Having more education can mean higher income potential, but sometimes it doesn’t, which is why it’s important to do research on your career’s income potential and run the ROI calculations first before assuming education debt.
Additionally, if you or your children spend too much on education to the point that you aren’t able to save 10 to 20 percent of your annual income toward retirement, it hinders the ability to build real wealth for the future.
Financial success is impacted by the sum of life’s choices, and for most that starts with how much you pay for education. Invest in yourself, but invest wisely so that you can get the highest return on your chosen career path.
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