Smart(?) Money
Today's lesson in voodoo economics is "Is a college degree worthless?" by Jack Hough in SmartMoney on MSN.com, June 20, 2009. The article blurb explains: "The higher incomes that college education brings may not make up for the savings it consumes or the debt it adds early in the life of a typical student." Hough lays out his scenario thus:
Consider two childhood friends, Ernie and Bill. Hard workers with helpful families, each saves exactly $16,594 for college. Ernie doesn't get accepted to a school he likes. Instead, he starts work at 18 and invests his college savings in a mutual fund that tracks the broad stock market.Bill will have higher pay than Ernie his whole life, starting at $23,505 after taxes and peaking at $56,808. Like Ernie, he sets aside 5%. At that rate, it will take him 12 years to pay off his loan. Debt-free at 34, he starts adding to the same index fund as Ernie, making bigger monthly contributions with his higher pay. But when the two reunite at 65 for a retirement party, Ernie will have grown his savings to nearly $1.3 million. Bill will have less than a third of that.When I read stuff like this, I give thanks for the War on Drugs, because there is no way drugs could not have been involved in that analysis.
How can that be? College degrees bring higher income, but at today's cost they can't make up the savings they consume and the debt they add early in the life of a typical student. While Ernie was busy earning, Bill got stuck under his bill.
Ernie
See "Note on Method" for a description of how I arrived at my results.
Let's start with Ernie. He starts off earning the average for a worker with no college degree: $15901 after taxes. Unless he wants to live in a slum, he'll pay at least $600 a month in rent, so roughly half his income will be gone right there. Add a couple thou a year for food and another couple for a car and we have maybe $4000 for everything else, roughly $11 a day, of which he's going to plow about $800 a year into investments. Utilities? Phone bill? Internet? Car insurance? Clothing? We'll presume Ernie doesn't have any vices like alcohol or smoking, because if he does, they will eat up his discretionary income in no time flat.
And Ernie had better hope he doesn't get sick, because he probably has a job with skimpy, or no, health benefits.
Is Ernie planning on having a sex life? Getting married? If he gets married, and his wife earns comparably to him, they may have something. One of the two salaries can go into savings and investments. But if they have children, fuhgeddaboudit. If the wife is a full-time parent, now Ernie is trying to support three people on a salary barely adequate for one. If the wife still works, there will be huge child care expenses. And kids have a way of ripping though family finances like a log chipper.
It is unlikely in the extreme that Ernie will be able to invest according to the scenario here. If he has the discipline of a Trappist monk, maybe. But all the odds are that he will not only not be able to invest, but he'll have to dip into his initial nest egg as well.
But hey, there's that $1.3 million waiting at age 65. All you have to do is spend 47 years at a job with mediocre pay, hoping you don't meet a catastrophe, to get it. Dead man walking. And if Ernie dies at 63, his heirs will have a good head start. He died with the most money. He won! Why would Ernie follow such a path? $1.3 million, at 8%, would yield over $100,000 a year. Why wait? Ernie could start tapping his investments for $10,000 a year around age 40 and still have enough for a $50,000 a year income at retirement. In this ideal world, he could. In the real world, where interest rates and yields vary all over the place, he'd need to monitor his investments very carefully to make sure he didn't over-withdraw.
Bill
Hough's analysis works only because he makes completely unrealistic, overly optimistic, assumptions about what Ernie can do on his salary, and equally unrealistic assumptions, this time pessimistic, about what Bill can do. In fact, the assumption of a large nest egg at age 18 so ridiculously slants the picture in favor of the no-college option that Ernie can invest nothing and still end up with more than Bill.
It it possible for Bill to out-earn Ernie? Easily. Bill gets out of college at age 22, at which time Ernie is earning $20337. Bill gets a job at $23505. Ernie has just over $30,000 in investments and Bill realizes he has catching up to do. Not having slept through econ, he realizes he needs to eliminate his debt and start plowing money into investments. So he pays $2000 on his debt and puts the rest of the salary differential, $1167, into investments. His net, after taxes, loan payment, and investments, is $20377 - exactly the same as Ernie.
Next year, since Bill's salary increment is greater than Ernie's, he decides to live it up a little. He pays $2000 on the loan, plows three quarters of the remaining salary differential into investments, and enjoys the remaining quarter. Ernie's net is $21446, Bill's is $22516. By age 32, on this slightly accelerated payment schedule, Bill has paid off his debt. He also has about $72,000 in investments, not far behind Ernie's $85,000. Ernie's net is $31428, Bill's is $34998. Now, considering he has more money to work with, Bill begins investing 6% of his salary.
Conventional wisdom is that it makes sense to pay debts slowly if the interest rate is low, and invest money elsewhere. The only problem is that, when things get tight, you have a choice whether or not to invest, buy a new car, or go on vacation. You don't have a choice about paying the debt. So my philosophy is to regain your freedom of choice as quickly as possible. One of the horror stories making the rounds these days is about a woman who completed medical school and is $500,000 in debt. That's why you pay off debts as soon as possible.
The following year, when both turn 33, Ernie plateaus out at $32538. Bill sees a big jump in his net since he is no longer paying off debt and his Spartan living period is over. He is actually investing less than the previous year (6% compared to 3/4 of the salary differential) and his net jumps to $45530. Bill tops out at age 37 at $53967, $21429 more than Ernie. At age 44, both have about a quarter of a million in investments, and Bill pulls ahead of Ernie, since he's investing 6% to Ernie's 5%. This might also be about the time Ernie looks in the mirror, decides his life sucks, and concludes he doesn't have enough money because teachers are paid too much. By age 65, Ernie has $1.3 million in investments, but Bill has $1.4 million.
But there's more to it than that. Bill had the same net as Ernie the first year, thereafter, he had more, every single year. By age 37, it's $21,000 more, and he out-earns Ernie at that level for 28 years until both retire at 65 - and he has more to retire on. It's not in the least difficult to come up with a plan where Bill outperforms Ernie in investments and has higher net income every single year.
So what can Bill do with the extra money? Apart from the obvious, having more and nicer things, going out more often, etc.
- He can buy a house. He can buy a much nicer house than Ernie. Now a ton has been written lately about the folly of regarding a house as an investment, all of it true, nevertheless, it has value that can be tapped if need be.
- He can build a big rainy-day fund. This is short-term savings for emergencies and desirables.
- He has credibility for loans. If he needs a big loan for a serious problem, he can get a bigger one, much more easily, than Ernie.
- He has a cushion. He doesn't have to worry about choosing between a new transmission and fixing the furnace.
- In a real crunch, Bill has a lot more room to tighten his belt than Ernie.
A More Realistic Scenario
Instead of Ernie having $16,594 right out of high school, let's give him a more realistic amount: zero. And instead of Bill's "typical" two years in a public university followed by transfer to a private university, let's assume he does all four at a public university, working during the summer and part time during the school year. He graduates with a modest debt, so let's say he isn't in a position to invest until he's 25.
Not having a head start of $16,594 cuts into Ernie's retirement just a bit. At age 65 he has $667,000, just about half of what he had under Hough's scenario. If he earns 8% at retirement age, he will make $53,000 a year from earnings - much better than he ever did from his salary. By the time Bill starts investing, Ernie has a $9000 head start. Let's assume that both invest at 5%. It takes a long time to erase that head start, but Bill's higher salary closes the gap. Bill pulls ahead of Ernie at age 50 and retires with $704,000. At 8% return, he will make $56,000, more than his peak salary.
So, Ernie has a choice. He can go to work at 18 and retire at 65 with an annual income of $53,000. Or he can go to college and enjoy that level of income at age 37.
And Another One
Words of wisdom from James Altucher in Yahoo! Finance (March 4, 2010), quoted in "Rethinking College as Student-Loan Burdens Rise."
There's a lot of evidence to suggest that motivated kids are going to make money whether or not they go to college," says Altucher, managing partner at Formula Capital. "So teach your kids how to be motivated. Teach your kids how to sell a product, build a network of connections. That's going to be far more valuable.Note it's not invent something, make something, or find a way to provide a service better or less expensively than before (like, say, writing open source software). It's sell a product and make connections. Park yourself in the money stream, diddle around with it a little, and rake off a lot. Gordon Gekko lives. "I produce nothing." And teach your kids to be economic tapeworms, too. This is a recipe for multi-generational social parasitism, only more lucrative than welfare.
100K for a degree: But with four years of college costing $104,000 on average (including books and tuition) and the average college student graduating with $23,000 in debt, Altucher argues it's time to rethink the value of four years of higher education, especially right after high school. He believes the vast majority of HS grads would be better off if tuition money was invested for them instead, as detailed here, or used to fund a new business or other "educational" endeavors like travel.Mighty generous of him to include tuition in all that. Shows he actually understands economics a little. Four years of living on the poverty line costs $100,000. Room and board are a wash, since students have to pay for those anyway unless they plan to live in the woods. Tuition and fees at my campus are $6600 a year and maybe a couple of thousand more for books and supplies.
Altucher notes the cost of college in the U.S. has risen 10 fold during the last 30 years, compared to a six-fold increase for health-care and three-fold for inflation overall. "College, not only is it a scam, but the college presidents know it. That's why they keep raising tuition greater than health care or inflation costs," he says.Let's see now. Thirty years ago computers were mainframes, there was no biotechnology, no cell phones, no Internet, no satellite TV. And unless Altucher wants to train his new hires on computers at his own expense (and you can just picture that), somebody else is going to have to do it. That means whoever does needs close to state of the art software and hardware. The vast majority of what people actually do with computers can be done in Windows 95 on a 386 computer. (That's productive work, as opposed to Web surfing.)
University tuitions rise faster than inflation for two reasons. First, technology is increasing faster than inflation, and is the principal reason why there's little inflation. Second, it's the flip side of everybody's "invest rather than pay tuition model." What happens if you don't invest during a period of inflation? Well, you have to play catch up and the starting line, let alone the finish, has moved way ahead. Using Altucher's numbers, inflation during the last 30 years was about 330 per cent. Now when did that happen? Mostly during the double digit years of the 1970's. And university budgets utterly failed to keep up. And let's not forget cutbacks in research funding as well. Pay me now, or pay me later. By the way, how much did hedge fund managers make 30 years ago?
The total fee for undergraduates at campuses including UCLA and UC Berkeley will exceed $10,000 an academic year by fall 2010. That annual fee was just $1,620 in 1990, and about $3,830 in 2002. Not surprisingly the fee hikes have sparked protests and anger -- especially as the state's budget woes haven't stopped top UC officials from pocketing base salaries of about $400,000 annually..Ooh! UC Berkeley and UCLA have about 30,000 students and about 25,000 employees each. How much would you pay a private sector CEO who ran a company of 25,000 employees? $400,000? Whoa, dude, that's like, $16 an employee per year! Outrageous. Considering that Altucher probably makes a heck of a lot more for doing a heck of a lot less, this is just idiotic. It's even more idiotic considering the whining from the business community that bankers deserve multi-million dollar bonuses even after mismanaging billions of dollars.
Oh, and it's okay to price gouge if you're oil, or health insurance, or the RIAA. But don't raise tuition.
Might not hurt to rethink letting certain people handle your money.
Let 'Em Eat Cake
There's a profound "let 'em eat cake" obtuseness in a lot of articles of this sort. The authors all seem to assume "I earn $100,000 after taxes, and I have no problem at all investing 5% of that, so if you earn $20,000, just invest one fifth as much." It's astonishing that people who write financial columns seem never to have heard of the concept of disposable income. That's income left over after paying obligatory expenses like rent and taxes, and necessities like food. Down where Ernie will spend much of his working life, discretionary income will be close to zero. If he does manage to save, it will be to cover foreseeable emergencies like car repairs, a new fridge, dental bills, and so on. This is based on my own experiences when my own net income was $15,000-$20,000 or so and mortgages and car loans were a lot smaller than they are today. I don't even want to think about trying to support a family on that income today, even after taxes.
It's interesting that so many studies on the cost of higher education drag private colleges into the mix. It's ironic in the same way that having the heroine of Atlas Shrugged be a railroad baroness is ironic, because it's hard to find two enterprises more slavishly dependent on government handouts than railroads and private colleges. Watch Harvard, Princeton and Stanford try to survive a few years without government grants. Watch private college enrollments soar if government financial aid is limited to public university tuition payment levels - not.
Overall, the scenario Hough lays out, starting off with a big grubstake and then assuming dependable 8% growth, is about as realistic as saying "if you hit a few Powerball winners, you can be a billionaire when you retire." In order to have that growth you have to know ahead of time which funds will perform that way and have an unbroken record of guessing right. It's like the character in C. S. Lewis' Pilgrim's Regress who proudly lays out his philosophy of total self-sufficiency (autarchia), until one of the travelers gives him a reality check:
"Your art then," said Virtue, "seems to teach men that the best way of being happy is to enjoy unbroken good fortune in every respect. They would not all find the advice helpful."
There are several fundamental fallacies that just keep cropping up repeatedly in these articles:
- Emphasize top tier and private colleges. Don't consider where most people actually go to college, at smaller public institutions. Don't consider attending a two year college first, or saving money by living at home.
- Ignore the fact that most students work and pay some of their bills as they go.
- Include room and board figures. Because people who don't go to college can do without food and shelter.
- Make wildly optimistic estimates of investment yields.
- Make utterly unrealistic estimates of what people with low and moderate incomes can invest.
- Assume that people of low and moderate income will never have an emergency that will require them to cash in on their investments
College, like everything else, is a matter of balancing costs and benefits. But the analyses should at least be done by people who are marginally economically literate. And the two authors above are completely illiterate.
Does it Pay to Go to College?
Numerous studies have noted that when you factor in the missed years of salary and job seniority, and the costs of student loans and supplies, it can take quite a long time for the higher earnings of college graduates to pass those of non-graduates. In fact, someone did a similar analysis during the 1970's, when inflation was running at double digits, and found that with high enough inflation rates, college graduates might never catch up.
Then there are the intangibles. If you go to college you either put off having a family or you struggle to make ends meet and balance study time with other obligations. On the other hand, you can have four years to experiment with your life.
So far, we haven't addressed what Bill and Ernie actually do from 9 to 5. Maybe Ernie is a landscaper because he loves watching things grow. Maybe he's a plumber, machinist or mechanic and makes more than Bill. There is absolutely nothing wrong with a skilled blue collar occupation. Maybe Bill works as a paralegal in a pro-bono poverty law firm and earns well below average for a college graduate because he believes in what he's doing. Or maybe Ernie just settled for the first job that came along and now feels trapped. Maybe Bill got a business degree because that was where the money was, but he's really not very good at it (both authors, above?), and he's also trapped.
So does it pay?
There's only one sensible answer: it pays if what you want to do with your life requires a college education. If you want to be a doctor, lawyer, scientist, engineer, manager, nurse or teacher, it pays. Because you don't get into those professions without a college degree. If you want to be in business or computers, it's a lot easier to get in the door with a degree, but it's possible to claw your way in without one. But you'd better be good, as opposed to merely thinking you're good. Bill Gates didn't finish college. On the other hand, would Windows have become the mess it is if he'd spent a few years learning some mental discipline? When you do something comparable to Bill Gates, tell me about how not going to college is a good idea. If you want to be an airline pilot, you'll probably need a degree, but a hitch in the Air Force will probably be more valuable. If you want to be a mechanic, plumber, or carpenter, probably not. Unless you also have a passion for history, literature, or science. Then it pays personally.
If you make your career choice based solely on earnings, do us all a favor and just go on welfare instead. You will cost society less in the long run. Some business somewhere will not have to put up with a clock-watching employee content to get by. And if you are contemplating a career because that's what your family expects, tell your helicopter parents to crash and burn, okay? Spare some profession the burden of somebody going through the motions in a job they hate.
