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.


  • 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.


  • 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)

How to Game the ObamaEd System

ObamaEd - how to game the system

I taught Cost Accounting for many years. I always had fun (okay, fun here is measured in the range of possibilities related to teaching accounting) covering the subject called Return on Investment (ROI), especially when it applied to selecting new products to add to your Product Mix with the goal of Maximizing ROI. The problem with trying to maximize ROI is that you are trying to maximize a percentage, and you can’t put percentages (as opposed to dollars) into the bank and pay your bills with it. The interesting part of the story (again, relatively speaking) is when managers make suboptimal decisions. A suboptimal decision is one that is in the manager’s (or his/her division’s) best interests, but not in the best interest of the company as a whole.

Yesterday, President Obama unveiled the first glance at his plan to give higher education an extreme makeover. Light on details, the plan does cover lots of ground, much of which would definitely upset some of the apple carts in higher ed. Trying to get a jump on the Tea Party – let me dub his plan “ObamaEd,” although I’m also quite partial to ObamaEd is probably DOA in Congress, if for no other reason than the fact that he proposed it. Therefore, the two factions of the GOP will oppose it, even though it feels much more like a GOP-colored proposal than one from the other side of the aisle.

ObamaEd is an attempt to hold colleges and universities more accountable for the federal dollars that flow into their coffers. Fair enough, I guess, but as soon as you start changing things like funding formulas, people start trying to find a way to game the system. Here’s one of the more significant proposals in ObamaEd.

  • New College Ratings before 2015. Before the 2015 school year, the Department of Education will develop a new ratings system to help students compare the value offered by colleges and encourage colleges to improve. These ratings will compare colleges with similar missions and identify colleges that do the most to help students from disadvantaged backgrounds as well as colleges that are improving their performance. The results will be published on the College Scorecard. The Department will develop these ratings through public hearings around the country to gather the input of students and parents, state leaders, college presidents, and others with ideas on how to publish excellent ratings that put a fundamental premium on measuring value and ensure that access for those with economic or other disadvantages are encouraged, not discouraged.  The ratings will be based upon such measures as:
    • Access, such as percentage of students receiving Pell grants;
    • Affordability, such as average tuition, scholarships, and loan debt; and
    • Outcomes, such as graduation and transfer rates, graduate earnings, and advanced degrees of college graduates. (emphasis mine)

Let’s just focus on the idea of basing the college ratings on the earnings of the graduates from each college. Not sure how big a role this will play, but let’s guess for now that it could be a significant factor. How do colleges game ObamaEd to their benefit? It’s really pretty simple. Start by cutting the programs with lowest rates of earnings for their grads. The earnings for the graduates of institution will be based on the average of all the different programs lumped together (or so it would appear at this time). Let’s take an example from the great state of Tennessee.  Using some of the data from a recent report by, here are a few of the programs at the University of Tennessee-Martin. I’m leaving out some of the detail, but the data below should illustrate my point.

Earnings of graduates at UT-Martin (pages 8-11):

  • Health Professions = $58,592 (highest)
  • Engineering = $52,976
  • whole bunch of stuff in between helps make the UT-M average = $37,140
  • Philosophy and Religious Studies = $27,094
  • Psychology = $26,205
  • History = $25,248  (lowest)

You don’t have to be a cost accountant (although it helps) to figure out that if you eliminate the History program, your average earnings for grads at the institution goes up. Think of the $37,140 as being a weighted-average (which means that it is weighted by the number of grads in each major) of the earnings of the grads from all the programs.  Get rid of the lowest-earnings program and your average goes up, and your federal rating goes up. The poor Psychology program is next. If it worked for History, it’ll work for them, too.

In fact, mathematically it will work for every program below the average. Just to add more intrigue, as you eliminate the lower programs, the average continues to go up, so that some programs that started out above the average, are now below the average and are now on the possible chopping block. If you carried it to the logical (okay, that’s a matter of opinion) conclusion, you’d cut everything except the Health Programs (uh oh, that’s another grouping of programs where some are better than others) and UT-M would now have grads that earn an average of $58,592 their first year out of college.

Would this be a suboptimal decision? Sure sounds like it. Would this actually happen? Probably yes, if we’re talking about cutting some of the lowest programs to bring up the average. Probably not if we’re talking about cutting everything except the highest performer.

However, you do need to be careful what you ask for.

(NOTE: in the maximizing ROI dilemma, the manager drops the least profitable product line, even if it is above the minimum level required by the company. Then drops the second least profitable line, etc., each time raising the overall ROI in the division. This makes his percentage go up, but hurts the company overall. Works the same way here with average graduate earnings.)