Investing Instead of Spending Your College Money

Money ball - decorativeThe onslaught of press about the value (or lack thereof) of a college education continues unabated. Here’s just a sampling of some of the articles about the cost of and/or value of going to college:

  1. Washington Post (8/27/13) The Tuition is Too Damn High, Part II: Why college is still worth it
  2. Cathy Davidson (8/24/13): Why Does College Cost So Much–And Why Do So Many Pundits Get It Wrong?
  3. Notre Dame Magazine (Summer 2013):  Is College Worth It?
  4. My own post: ROI on Tuition Paid – Another Bunch of Hooey (also More ROI Hooey)
  5. Also mine: Series about the $10,000 bachelor degree (10+ posts  altogether)

There’s many more to choose from, but you get the idea. So let’s say that you have a hypothetical child that is about ready to enter college. She’s a slightly above-average student, but not a star student. She has more personality than you can shake a stick at, but not the greatest amount of ambition to change the world. She’s uncertain about where she wants to go in life (you know, the career thing), and so she’s having a hard time figuring out where she should go to college and what she should major in. The idea of going away to an exotic land with fabulous dorms and climbing walls (sorry, but everyone has to throw that into the equation) is something that she is very interested in. Her parents are not made of money, but they have done some saving for college expenses, just not the kind of money that can afford the out-of-state or private school climbing walls.

The parents are able to pay $5,000 per semester for 4 years, or a total of $40,000. A four-year degree in 4 years is the exception rather than the norm, but that’s the way they’re figuring the finances for now. Pell money will be scarce because their family income is just a little bit too high. Burdening the young lady with mountains of debt doesn’t seem like a good idea to any of them.  State grant money is very uncertain, and so are scholarships (remember, she’s a slightly above-average student without severe financial need).

Although the young lady doesn’t like this idea, she can live at home and attend the local state university in her home town. The cost of tuition per year is about $8,000 and books and supplies will run about another $2,000 – thus, the $10,000 per year that her parents have available would work in this scenario without incurring debt. Living outside of the home, whether in the same town or not adds a significant amount of cost, so let’s assume that the parents are going to strong arm her into living at home, at least for the first couple of years (actually, all 4 years, but they keep that to themselves).

Here’s the $64,000 question (OK, the $40,000 question):

Should they pay for her college, or just invest the money for her retirement?

What if she doesn’t go to college? Maybe on her own she could take a few classes here or there and over time build towards a college degree (or get herself a free, shiny MOOC degree!). Or maybe she gets a job with an employer who is willing to subsidize her higher education (increasingly rare, but they’re still out there). Or maybe she avoids much of the ladder-climbing rat race and works at jobs that don’t require a college degree, makes enough money to live off of, and basically coasts to the finish line where there’s a pot-o-money waiting for her. Or, any one of the hundreds of other ways that this could play out.

Assume Mom and Dad invest $5,000 in her name every six months for four years – the same $40,000 that they would have paid for her college costs. Investing in a mutual fund that mirrors the S&P 500 tends to be a good gamble over the long run.  The long-run here would be a 44-year investment, the first 4 years of which find her parents paying into her “not college” fund, and the next forty years of compounding. The no-longer-young lady would be 62 years old when she is able to get her hands on the investment spoils. Historically, the S&P 500 returns an average annual rate of approximately 10% over 30 years or more. Of course, past results are not necessarily indicative – blah, blah, blah. So, let’s look at a range of outcomes from 7% to 12%.

  • 7% annualized rate of return:  = $701,441*
  • 8% annualized rate of return:  = $1,040,908
  • 9% annualized rate of return:  = $1,539,394
  • 10% annualized rate of return:  = $2,268,974
  • 11% annualized rate of return:  = $3,333,329
  • 12% annualized rate of return:  = $4,881,136

* The $40,000 investment (8 annuity payments of $5K each, every 6 months for 8 periods), then 40 years of growth at 7% without additional payments.

Caveats:

  • These numbers are pre-inflation. In other words, at the 8% return, it’s not the same as having a million dollars today, but whatever a million dollars will be worth 44 years from now.
  • Any mutual fund will have annual expenses and admin fees to pay. Several analysts seem to suggest that 1/2 of 1% (annually) is a good estimate for a long-term mutual fund with minimal activity.
  • Income taxes can always be a thorny issue. The $10,000 annual contribution by the parents should be tax-free since the gifting limit is $13,000 per child, per year. Taxes on investment income will need to be paid at some point. The first $5,000 each year should go into a Roth IRA, which is the Roth contribution limit per year, and also assumes that the young lady will have earned income of at least $5,000 each year during those first four years. Another advantage of a Roth IRA is that no tax on the earnings is due until the earnings are withdrawn – and by then she’ll have the money to pay the taxes with the investment income. The parents need to be able to contribute an additional $5K per year on her behalf in a tax-friendly way. There are options to consider, but even a regular investment account during those first four years will not earn a large amount of taxable income (taxed at her supposedly lower tax rates). Then, starting in year 5 she begins converting the investment account into the Roth IRA account until that transfer is completed.
  • Taking inflation, expenses, and taxes into consideration – you could probably take 25-30% off the accumulated amounts above to see what might happen in today’s dollars.
  • Of course this could go horribly wrong and she would hate you for ruining her life.

Additional thoughts:

  • Expect another post (one of these days) that goes into more depth on this point, but I absolutely do NOT buy the argument that the only way that a person can become properly socialized is to go to college – you know, all the learning that happens outside of the classrooms. Life experience can be gained in many ways – college does not have a corner on that market.
  • Compare this with the analyses about how much more someone will make with a college education than without one. There’s many studies out there, but this one gets to the point in easy to understand terms: The Big Payoff: Educational Attainment and Synthetic Estimates of Work-Life Earnings (PDF, U.S. Census, 2002). They estimate that a holder of a bachelor’s degree will make $900,000 more than the holder of a high school diploma over their entire working life. YMMV. Compare that number with the amounts that the not-college investment will grow to, and the bachelor’s degree is not such a no-brainer. A more recent analyses (2011) by the Census Bureau indicates that a white female with a bachelor’s degree will earn about $845,000 more during her life than a white female with a high school diploma (for full-time, year-round workers). The one thing we don’t have data on is what that white female (with B.S) will have in a retirement account at the end of her career. It had better be substantial or my argument above still holds.
  • I realize that there’s a difference in the unemployment rate for diploma holders compared to degree holders – but some people (those with lots of personality and a good work ethic) will fare better in finding and keeping those local jobs than others.

Conclusion:

  • I’m not an anti-college guy, I’m a pro-college guy. I spent 17 years as a college faculty member and 10 years as a college administrator. Most of my friends work in education. I still work with educators in my current job. I think college is GREAT!
  • I also think that college is not for everybody. It’s crucial for the professions, it’s helpful in STEM fields, it’s a seal of approval for many jobs and career aspirations. But, it’s not the only way to get ahead. Why not spend 40 years at jobs you enjoy that pay you enough money to get by, then retire with a million dollar nest egg. Then build your own climbing wall.
  • If the young lady really wants to go to college, and if she has a plan for how to start AND finish that adventure, and if she is willing to do it in a manner that doesn’t break the parent’s backs or burden her with debt (add in a few more ifs just for good measure); then she should probably go to college.
  • One question I have is this: how many young people would look at these two options below and choose option B?
    • A) Go to the college of your choice and spend $10,000 per year of your parent’s money (for 4 years) – incurring debt for all other costs that you cannot pay with their contribution.
    • B) Find a job you enjoy without a college degree, and let your college money grow to a million dollars or more for your retirement.

Any hypothetical kids out there want to choose option B? Hypothetically?

(Graphic courtesy of geralt at Pixabay)

4 Responses

  1. My 2c worth: Education is not about the money, well it shouldn’t be about the money, but I believe that we lost the plot completely when it became all about the money and calculations like the one you draw our attention to. So now our education is all about obtaining degrees so that we can earn the money and not about learning. The upshot of this is that education has become a negotiation. The student says: “I want xyz degree.” The teacher/institution says “in order to obtain xyz degree you need to jump through these hoops.” That’s the sadness of it all for me. I re-read Zen and the Art of Motorcycle Maintenance recently – grade-less learning, now there’s a novel thought, or is it?

  2. Hi Andrew, it’s great hearing from you. Hope life is good for you back in your home country. You make a good point about the focus on money instead of learning. I will say that they’re both important to me. As a lifelong educator – I want to see the focus on the learning. As a parent who has three kids who might be on their way to college – I have to be concerned about the money as well. Sadly, just about everything has become a negotiation – not just education. I have been an advocate for grade-less learning for many years now, partly because that was the part of my faculty jobs that I absolutely despised (I always envisioned the giving of final grades as taking a red hot branding iron and stamping each student with their net worth – “You’re a C student and you’ll always be a C student!”). Still makes me cringe to this day.

  3. Hey Barry, all is well in Africa. Just read a re-tweet from Michael Moore originally from Ted Hope (not sure who he is or where the stat comes from) which says “avg CEO of a company makes 354 times as much as the average worker, up from a ratio of 42:1 when Ronald Reagan was president.” This, in itself, is shocking (if true).So my question is what will your kids do with their lives in the intervening 40 years before cashing in on their million+ dollar bonus? I suppose it’s a little different here in South Africa with unemployment running at 20+% and if you don’t have tertiary education you have little chance of finding a job. So the question about what kids without an education will do in the intervening 40 years is more real than in the first world perhaps. But imagine if every American parent today decided to forego a college education for their kids in favour (favor :-)) of a million+ dollar payout, where would that leave your country in 40 years? I know this is about highlighting the cost of education and not education per se but I am not sure the debate is framed in the right context. It would concern me that people are even considering foregoing education for their children in favour of a later in life payout.

    If the debate is framed in the context of education reform in general, including but not limited to the cost of education, then we may be on to something. Sadly, the cost of education reform is considered by most too great a burden.

    As for grade-less learning – bring it on, it’s long overdue!

  4. […] You can read his blog post — with his explanations and caveats — here. […]

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