There will inevitably be someone in a net worth related article comment how he or she isn’t doing so great due to all of his or her student loans. Because so much of wealth creation is about having the right positive mindset, I fear folks burdened by heavy student loans may be dragged down by a defeatist mentality.
I’d like to change this mindset by placing a specific value on our higher education. The older I get, the more I realize education is the most valuable asset of all. Education is what will break the poverty cycle. Education will provide the means for people to become better communicators, better employees, better entrepreneurs, and better citizens. Yet curiously, we pay our high school educators some of the lowest wages and charge exorbitant private college tuition. Sounds like a good business to own!
Nobody spends money on things that aren’t worth its value unless they are being extorted. The item might lose value over time, but at the time of purchase the value is worth exactly its price. So when someone comes to me and says they have a negative net worth of $30,000 due to $35,000 in student debt, I’m going to counteract their belief by asking what they spent on their college tuition to come up with its value.
DECIDING ON HOW MUCH TO PAY FOR COLLEGE
There’s one simple financial rule for deciding which college to pay for. The total tuition cost for getting a diploma must be no greater than the expected full-time income of your first job. Your expectations may turn out incorrect, but you’ve got to at least do research to figure out what the expected wages are for various positions of interest.
Example #1: I went to William & Mary, a state school that cost $2,900 a year in tuition from 1995-1999. $2,900 X 4 = $11,600. I would need to find a job in 1999 that would pay me $5.60 an hour compared to the then minimum wage of $4.25 an hour to make attendance worthwhile. I strongly believed I could find a $11,600 a year job because I was the best damn Egg McMuffin maker during my time at McDonald’s! Besides, I frequently saw friends of equal academic stature get jobs for $30,000 a year or more out of W&M.
Decision: Attending W&M was a no brainer and is still a no brainer for in-state students where tuition and fees total $7,700 a year. You should be able to get a $30,800 a year job if you get a full-time job today. If we were to just look at W&M’s tuition of $5,400 a year, then getting a $21,600 a year job should be relatively easy.
Example #2: Boston University tuition is currently $43,000 a year. The total tuition cost over four years is at least $172,000. The probability of landing a $172,000 full-time job right out of BU is probably less than 0.1%. But as Jim Carrey says in Dumb and Dumber, “So you’re telling me there’s a chance? Yeah!”
Decision: It’s probably not a good idea to go to Boston University without scholarships unless your family has a lot of money. Consider U. Mass, Harvard or MIT instead if you must go private in Boston.
Example #3: You attend University of Michigan as an out-of-state student who pays out-of-state tuition of $20,500 a year compared to $6,750 for in-state students. The estimated four your tuition cost is roughly $82,000, which is not bad compared to private schools.
Decision: UoM is one of the top five state schools in the country with an enormous alumni base. Finding a $82,000 a year job is possible nowadays in tech, internet, banking, and management consulting if you are a top student. Green light, even though that’s a Michigan State color.
Example #4: You attend Princeton University with a need based scholarship of $15,000 a year that brings down annual tuition from $41,750 to $26,750. The total estimated tuition over four years is a more digestible $107,000.
Decision: Princeton is perennially one of the top five universities in the world. After bonus, you have a shot at making $107,000 a year after your first full year of work. First year investment banking analysts have a base pay of $70,000 – $75,000 with a bonus of $20,000 – $50,000 for example. There are Princeton clubs in all major cities thanks to their strong alumni base and huge university endowment.
Example #5: You attend Chico State University for $7,000 a year as a California resident. It takes you 5.5 years to graduate at a total cost of $38,500 because you receive no help from your parents, the school, or the government. You’re working summers and part-time to get a college diploma. Solid effort!
Decision: Graduating from Chico State is much better than not graduating from college at all. It may be better to lower your tuition cost by attending community college for the first two years at $1,500 a year, and trying to graduate in 4.5 years to knock off a total of $10,000 from the education. $28,500 a year is a much easier target to achieve as a first job than $38,500 from Chico.
VALUING A COLLEGE EDUCATION
Now that we understand how much to pay for college, we must now value the college education as part of our net worth. Intellectual capital’s value is highly underrated because it’s not tangible. Yet higher education tuition is largely inelastic thanks to tremendous demand. How inconsistent is that?
Because we structure our college decision based on the expected value of our first full-time job upon graduation, then we must assign an education value that is equal to our full-time job’s annual total compensation.
We do not know during college whether we will be able to earn more than our total tuition cost. But we will all eventually find out whether our estimates prove correct or not because the large majority of us will eventually land a full-time job at some point. This is where the initial rise and fall of our college education value comes into play.
Example #1: My first full year base salary was $55,000 back in 2000 (it was $40,000 when I started in the summer of 1999). I could therefore value my college education not at $11,600 (the cost of four years of tuition), but at $55,000 in my net worth calculations if I was that big of a personal finance nerd back then. The calculation should be on total compensation, but I am reluctant to share my first full year bonus at this time. Because I didn’t feel encumbered by a negative net worth, I took way more risks the first two years than I would have otherwise. Part of it paid off through a lucky stock purchase. Part of it didn’t pay off because I was too cavalier with my career.
Example #2: The Boston University graduate finds a full-time job for $50,000 as a marketing analyst. $50,000 is a very admirable salary, but the value of his education declined by $122,000 ($172,000 tuition – $50,000 salary). Let’s say he calculates his net worth as negative $40,000 due to $30,000 in student loans, $10,000 in credit card debt, and $0 assets. He can actually increase his net worth by $50,000, the new lowered value of his education based on his first year’s annual income. Being able to believe in a positive $10,000 net worth vs. a negative $40,000 net worth should help this student be more confident. With more confidence, comes more achievement. With more achievement comes greater rewards and happiness.
Example #3: The University of Michigan graduate leaves the frozen plains for a tech job at Google for $65,000 + $15,000 in stock options. The value of her $82,000 education only lost $2,000. Instead of starting off with a negative $20,000 net worth due to some student loans, the new Google employee has a net worth of roughly $60,000 ($80,000 value of education – $20,000 in student loans) her first year out of school. Landing a job at Google is already like winning the lottery. To assign a value to her lottery winnings should make her feel even better about life.
NET WORTH GYMNASTICS
The whole goal of this exercise is to get parents and high schoolers thinking about the cost benefits of going to a particular college as well as giving people with heavy student loans the belief that things aren’t so bad. Net worth calculations are largely academic because until there is a liquidation of your assets or an income realization from intangibles, everything is subject to change.
The risk of assigning value to education is the delusion that you are worth more than you really are. When you are delusional, there’s a chance you become over confident and take excessive risk. Risk taking is great, but there needs to constantly be an analysis of risk and reward. If you don’t calculate a realistic reward scenario, then you are facing asymmetric returns which could prove devastating to your finances in the long run.
Valuing your college education equal to your first full-time job’s total compensation makes a lot of sense in the short run. In the long run, the value of a college education really starts to compound towards the ultimate goal of absolute freedom. So the question becomes: How much is freedom worth to you? Priceless I say.
1) Initial college education value = what you pay in tuition to achieve your diploma. You wouldn’t pay the tuition if you didn’t think the college was worth it.
2) Real college education value = total annual compensation for the first full year of work after graduation. Time to face reality and see what the diploma gets you.
3) If college X’s tuition is less than or equal to the expected total salary of your first year post college, then it is economically fine to attend college X. You never know the future, but you should have a good sense of how much your desired occupation will pay.
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Updated for 2018 and beyond.