A college degree has always been perceived as valuable. Besides the prestige, it usually brings lower unemployment rates and higher wages. And many studies have been conducted like this one at the Washington Post, which states that “Going to college is worth it – even if you drop out”! They reinforce the notion that over one’s lifetime, a college degree is worth dramatically more to the recipient than not graduating from college. But is it?

Parents will intuitively send their children to the best schools they can afford. And even on the question of affordability, parents and students have been willing to incur debt to afford more expensive schools because of the perceived benefits of a college degree. Therefore, over $1 trillion is owed by families, as they have made significant investments in higher education.

Do these investments make sense? Are the perceptions of value borne out?

Unfortunately, the reality may be starker than you have been led to believe. Often, the investment you are making in that college degree may not be worth it. Let me explain why, and show you how to make more fact-based and logical choices, so that your investment in education ultimately proves valuable.

Don’t read the headlines. Those studies are wrong!

Many studies that show how much more money you earn because of earning a college degree are flawed. They are simplistic and not based on the underlying economic fundamentals of the choice and other reasonable alternatives. Several studies are so simple, they don’t even adjust to the fact that you will work fewer years while attending college. Worse, “Time value of money,” the most basic of financial truths, is completely ignored in their evaluation, and the conclusion is ultimately wrong.

How should you view the investment in a college degree to figure out its ultimate worth? Well, quite simply, in choosing to attend college, you give up the option of working after High School, and you will pay fees while in college. The payoff is that upon graduation with your college degree, you will receive a higher salary than a high school graduate. You would like to see that over the lifetime of your employment, the incremental wages you earn by attending college would more than offset the fees you paid and the wages you could have earned while attending college.

Those studies use these factors to show that, on average, the total wages earned by a college graduate over their lifetime exceed those earned by the average high school graduate. Where do they go wrong? Simple, they fail to adjust for the fact that a dollar today is actually worth more than a dollar tomorrow, “The time value of money.” You see, every investor knows that you should not just watch the cash inflows and outflows without considering when they occur and adjusting them for their real worth over time. You inherently know that no one will lend you $1,000 today and ask you to pay them back $1,000 five or ten years from now. That is because you know that the $1,000 should earn some interest, and you would expect to receive more than just $1,000 back. Therefore, we need to adjust those future earnings for the “Time value of money.”

Further, you don’t get to keep all those incremental wages. The government takes some of it in taxes. Thus, a failure by those studies to reflect tax differences and the time value of money leads to fatally flawed conclusions.

The right way to evaluate College Degree investments

Let’s look at an example and show you the difference:

According to the Bureau of Labor Statistics, in Q3 2012, the median weekly wage earned by a High School graduate was $648, while the median weekly salary earned by a college graduate was $1,071. Between Q1 2002 and Q3 2012, both wages increased at an average annual rate of 1.97%. Let’s assume that wages are increasing each year in both categories at approximately 2%. For simplicity, let’s assume someone leaving High School now has a choice of the $648 per week ($33,700 per year), or emerging four years later from college into the workforce and earning slightly higher $1,159 per week ($1,071 adjusted for wage inflation of 2% per year, or $60,270 per year). The National Center for Education Statistics indicates that the average fees paid in a private institution last year were $32,900, and that prices have been increasing at a rate of 5.6% per year over the last decade. Therefore, let’s assume that’s what our college student will pay.

Lifetime Earnings (Absolute dollars earned assuming retirement at Age 65):

This is clearly the study that everyone uses to promote the idea that a college degree is worth it; after all, you earn $1.3M more over your lifetime.

But what happens if we adjust those inflows and outflows over the more than 40 years of payments and earnings, taking into account the time value of money? The federal student loan rate for direct loans is at 7.8%, so let’s adjust all the cash flow each year using this discount rate. This is referred to as the net present value (NPV).

NPV of Lifetime Earnings (Assuming retirement at Age 65):

What is happening here? Well, in trading off earlier wages and paying to do so, you have to earn that much more in later years to compensate for those.

And it gets worse. If we adjust for taxes and then discount for the time value of money, this is what that comparison looks like:

After-Tax NPV of Lifetime Earnings (Assuming retirement at Age 65):

We used the 2012 Federal Tax Rate Structure for a single individual, which included a $5,950 standard deduction, a $3,800 personal exemption, a 4.2% Social Security tax, and a 1.45% Medicare tax applied to a maximum of $106,800 in annual wages. No state or local taxes were assumed.

The result is an investment that is actually economically worse than the alternative. The combined effect of taxes on wages and the time value of money makes what, on an absolute basis, seems like a great deal a very poor economic decision.

Clearly, if you can pay less than what was assumed here for college, either by going to a less expensive institution or by getting grants to reduce your outlay, the college degree investment would improve.

What can you do?

The value of a college degree depends on the right combination of college selected, the cost of attendance, and the college major. It’s simple. The less you pay for college, the higher you get paid upon graduation, the better off you are. Get those wrong, and you end up with a decision that will cost you money. That is why we built a comparison tool to help you understand these choices and their financial implications. You can check it out by going to the College ROI comparison tool.

One last point. Our tax structure is a disincentive to earning more. It does not consider the sacrifices that a college student makes when they forego income or the investment they make in their college degree. We all have an obligation to get that fixed!

What do you think? Add your views by commenting below!

This article on the value of a college degree was first published on www.shivamber.com

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