Is College a Good Investment?

July 2, 2010

Together with Bloomberg BusinessWeek, PayScale on Monday released a report on the return on investment (ROI) in education at 554 bachelor's degree granting colleges and universities

All together, the PayScale College ROI Report ranked 852 possibilities, evaluating public universities for both in-state and out of state tuition costs.

Why evaluate college tuition as an investment? There is a clear analogy from the housing market.

Conventional wisdom used to say that buying a house was always a great investment, offering returns of 10% or more a year. As many have painfully learned over the last few years, buying a house at the wrong price can be a bad investment, particularly if you borrowed too much to pay for it.

Do You Know What You're Worth?

Conventional wisdom also says that paying for tuition, room and board for a 4-year bachelor's degree, no matter what the cost, is a great investment, offering long term returns of $1,000,000 or more over going to work straight out of high school.

The PayScale College ROI report shows that the return varies tremendously across schools. Netting a million dollar payday is far from a sure thing.

In the next few blog posts, I'll cover the basics of our methodology, why we made the choices we did in calculating ROI, some guidance on how to use this to evaluate college choices and costs, and respond to some of the criticisms.

Whether you went to college or not, are you earning what you are worth? Spend 5 minutes completing the PayScale online salary evaluation survey and know.

When is an Expense an Investment?

The PayScale College ROI Report should open people eyes' to when paying for a 4-year college degree is making an investment in higher future earnings, vs. when paying is simply buying a great experience (a consumable).

Depending on the school, paying for tuition can be more like buying a ticket to a great play than buying a share of stock. Worth doing, but not to be confused with an investment.

Return on Investment is the idea that you eventually get money back (return) for the money you spend (investment). This is what distinguishes an investment from just something you buy for your consumption (a consumable). Investments hold out the promise of returning more money than they cost.

Most of the money people spend is on consumables. I know full well that 52 inch TV I bought isn't an investment. It started declining in value the day I took it home. I would be lucky to sell it today for 20% of what I paid for it two years ago.

There are only a few areas where regular people talk about investments, in the financial sense:

Stocks and Bonds: pure investments – why buy them, unless they yield more money in the future than they cost now?
Houses: this is tricky: a place to live that wears out (a consumable) and land speculation (an investment)
Education: Almost universally talked about as an investment, but there no explicit guarantee of future return

To rank the schools, we want return on investment: how much more money will going to a college bring over the alternative? We measure this with a 30-Year Net Return on Investment.

What is 30-Year Net Return on Investment?

The 30-Year Net Return on Investment is the value in 2010 dollars (real value) of additional earnings after graduation, after costs and the probability of graduation have been considered.

It is based on four key factors when considering education as an investment:

Educational Cost: the direct costs you pay to earn a degree.
Graduate Earnings: No one will buy your degree, but they will pay you to work using what you have learned.
Opportunity Cost: If you weren't going to school and then working as a college graduate, you would do something else – what does that pay?
Graduation Rate: The value in future earnings of attending college is typically much less if you don't graduate – Mark Zuckerberg and Bill Gates don't count; they own their own businesses 🙂

To calculate the 30-year Net Return on Investment, we simply:

add up median earnings of graduates over the 30 years after graduation (Graduate Earnings)
subtract the earnings of a typical high school graduate over 34 to 36 years after graduation (Opportunity Cost)
subtract the 4 year total cost of education for a 2009 graduate (Educational Cost)
multiple the result by the graduation rate

We calculate the Net 30-Year ROI in 2010 dollars, since these are the only dollars anyone really understands.

As an example, based on earnings data for grads from 1980 to 2009,

the sticker price for MIT in 2009 was about $190,000 for 4-years
the typical MIT grad earns about $3.1 million (2010 dollars) over 30-years after graduation
the typical high school grad (no higher degree) earns about $1.1 million over the 34 years the MIT grad spent in school and working
94% of entering freshmen graduate from MIT
yielding $1.7 million in Net 30-Year Return on Investment for MIT students

In the following posts, I'll look at each of these four factors in turn, explaining why we calculated them the way we did.

One sure way to maximize your personal educational ROI is to earn what you are worth. For powerful salary data and comparisons customized for your exact position or job offer, build a complete profile with PayScale's Salary Survey.

Cheers,

Al Lee
Director of Quantitative Analysis, PayScale, Inc.