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Wednesday, February 28, 2024

How To Calculate The Value Of A College Education

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Let’s say you’ve just graduated college and have a negative net worth due to student debt. Don’t fret. You actually have a higher net worth than you think! This post will help you calculate the value of a college degree.

A college degree is a valuable asset. Millions of people are willing to dedicate 4-6 years of their lives and hundreds of thousands of dollars to get a college degree. Therefore, of course a college degree is an asset!

We know that Net Worth = Assets – Liabilities.

We also know the net present value of an asset is equal to its future cash flows discounted by an estimated growth rate. In this case, the future cash flows of a college degree is equal to the college graduate’s lifetime earnings.

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Various Ways To Calculate The Value Of A College Degree

For those of you who are upset about the Supreme Court rejecting Biden’s plan to wipe away $400 billion in student loan debt, this post should help you feel better about paying back your loans. In turn, you’ll improve your odds of building more wealth, satisfaction, and happiness. A quadruple win!

Here are three ways to value a college degree as an asset in your net worth calculations.

1) The cost of college plus a conservative rate of return

The first way to calculate the value of a college degree is to add up the cost of a college degree. We then add on rate of investment return you would have earned if you had invested the money instead.

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To be conservative, we can use the risk-free rate of return (10-year government bond yield). Or we can use the risk-free rate of return plus a small premium.

For example, let’s say you paid the full cost to attend Boston University for four years. Let’s assume each year the total cost increases by 5% a year. We also assume room and board and fees are included in the cost of college. The cost would be:

  • Year 1 (2024): $86,363
  • Year 2 (2025): $90,681
  • Year 3 (2026): $95,215
  • Year 4 (2027): $100,000

Total cost of college: $372,259 with the average cost per year at $93,064. Assuming a 5% annual investment return had you invested the money instead, the total cost of college for four years is about $534,000.

Therefore, the total value of a college degree is equal to at least $534,000. A big assumption is that we are rational actors. We would not pay the money or spend the time to get a college degree from Boston University if we did not think the investment was worthwhile.

Let’s say a Boston University student graduates with $120,000 in student debt and no other debt. Their net worth is actually equal to $534,000 minus $120,000 = $414,000. Not bad!

Implications Of The Cost Method Of Valuing College

Here are some other assumptions if we value a college degree based on the cost method.

  • The more you pay for college, the greater your net worth.
  • The elimination of Affirmative Action reduces the net worth of college graduates who were helped by Affirmative Action
  • Wealthier families who can afford to pay more for college end up having college graduates with higher net worths.
  • Students who reduce the cost of college by getting grants or scholarships are able to “freeride” and benefit from the full value of a college degree. Employers don’t pay candidates less because candidates paid less for college.
  • Overall, private university graduates are wealthier than public university and community college graduates.

2) The Value Of A College Degree Is Equal To The Estimated Lifetime Earnings Of The Graduate

According to the Georgetown University Center on Education and the Workforce, it estimates the lifetime earnings of a Bachelor’s degree holder is $2,268,000. Therefore, we can also assume the value of a college degree is worth about $2,268,000.

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Suddenly, paying the outrageous sum of $372,259 for four years at expensive Boston University or any other private university sounds like a good deal!

Unfortunately, in order to earn $2,268,000, you’ll have to work until the assumed aged. So valuing a college degree equal to the estimated lifetime earnings of the graduate may not be the best method.

Let’s assume the age until a college graduate stops working is 62, or 40 years of work post college. The average income earned for a college degree holder is, therefore, $56,700. This seems reasonable, if not a little low in my opinion.

However, given it takes 40 years to earn $2,268,000, it is not fair to use the estimated lifetime earnings of a college graduate to calculate a college’s value. Due to expected real investment returns, we should discount the value of $2,268,000 to come up with a value in today’s dollars.

3) The Value Of A College Degree Is Equal To Its Net Present Value Of Future Cash Flows

The most accurate way to calculate the value of a college degree is to conduct a net present value (NPV) calculation. In the NPV formula, all future cash flows (CF) over some holding period (N) are discounted back to the present using a rate of return (r). This rate of return (r) in the above formula is the interest rate, which is commonly called the discount rate.

Discounting is merely the inverse of growing.

Let’s assume the following assumptions for a college NPV calculation:

  • discount rate is 5%
  • cost of college $327,259
  • the college graduate works 40 years
  • makes $56,700 a year
  • the total value of 40 years of earnings is $2,268,000.

If you input these figures in an NPV calculator, you get $629,387.

Therefore, for this Boston University graduate who paid full freight, the value of their college degree is equal to $629,387. The $629,387 includes the person’s cost of paying $372,259 for four years of tuition.

Below is what the NPV calculation would look like, truncated at period 4. The calculation goes for 40 periods because the college graduate works for 40 years.

NPV calculation to value a college degree from a 4-year private college

The Discount Rate Is An Important Variable

If I use a discount rate of 4% instead of 5%, the value of the college degree rises to $782,000. If I use a 3% discount rate, the value of the college degree rises to $974,000. Finally, if I use a 2% discount rate, the value of a Boston University college degree surges to $1,218,471.

Why does the value of the college degree rise when the discount rate falls? It’s because the value of the cash flow is worth more because it is getting discounted less.

Imagine a discount rate of 100% due to hyperinflation. The value of $1 million, 40 years from now will be worth much less than if inflation was worth only 1%. With inflation only at 1%, the price you pay for college holds its value more.

Put things differently, if inflation was running at 100% a year, taking four years to graduate is much more costly. In such a scenario, you would want to graduate sooner to make more money. At an inflation rate of 1%, you can take your sweet time in college.

More Years Worked, Higher College Degree Value

It’s harder to control how much you will make per year in your lifetime. However, you may have better control over how many years you work.

If you want to increase the asset value of your college degree, then you should increase the number of years you work. If you want to FIRE, then the value of your college degree will decline.

Hence, for those of you who want to get Masters and Doctorate degrees, please be prepared to work for as long as possible! To retire early after spending so much time and money on education is a suboptimal financial move.

College Graduates Can Now Boost Their Net Worths

Some of you might argue that I’m being ridiculous for assigning an asset value to a college degree. If you do, then you can also argue that everything we invest money in, like stocks and real estate, also has little-to-no value.

The Nvidia stock you buy trading at 40X annual revenue is a leap of faith. You will have to wait 40 years to generate enough revenue to equal its current market capitalization. With an estimated 28% net profit margin, you will have to wait 142 years for the company to make enough profits to equal today’s market capitalization. Nvidia has a tiny dividend of $0.04 / share.

Given we agree that funny money stocks, real estate, and other investments are considered assets in our net worth calculations, so should a college degree. You can even argue a college degree should be an even more worthy asset than stocks and real estate given most people have to spend four years obtaining the degree.

Therefore, every one of us should be able to boost our net worth by the value of our college degree. If we have multiple college degrees, then we can boost our net worth even further.

This should be welcome news for Masters and Doctorate degree holders who’ve spent many more years getting educated. Congrats folks!

In the past, many professional degree holders have lamented how they are so far behind in terms of my average net worth for the above average person chart. With the addition of the value of a college degree as an asset, the gap will narrow or be completely eliminated.

Adding At Least $122,000 To My Net Worth

Using the cost plus methodology to value my college degrees, I’ll be able to add $122,000 to my net worth if I want to. The College of William & Mary cost $44,000 for four years from 1995-1999. UC Berkeley’s Haas School of Business cost $78,000 over three years, given I went part time.

Perhaps I should increase the value of my college degree given an NPV calculation is more accurate. After all, I worked in banking for 13 years, made decent money every year, and retired early with a ~$3 million net worth.

However, I’ve come to believe college can only be accountable for, at most, the first thirteen years of my income generation. The remaining eleven years of income and net worth really came from my investments, entrepreneurial hustle, and individual educational endeavors (e.g. reading books).

Therefore, perhaps the Cost Plus way to calculate the value of a college degree is most appropriate. Once you get your first job, it’s really what you do after that matters more for your income.

Using my logic for valuing college degrees, I now feel less bad about potentially paying ~$750,000 for four years of college in the year 2038. My assumptions are no scholarships and a 5% compound annual growth rate of based on the average four-year cost of a private university today ($350,000).

Hopefully, this article makes all parents and college-bound students dreading paying for college feel less bad as well!

Although the return on a college degree is diminishing, it is clear the income potential for college graduates is much higher than those without college degrees. The best-case scenario is to attend a reputable four-year college for the lowest price.

The Value Of A College Degree Increases Every Year

One final point I’d like to make. Thanks to aggressive cost inflation, the value of your college degree is increasing every year. As a result, the value of your college degree is boosting your net worth every year!

Although it cost me $44,000 to go to William & Mary for four years as an in-state student, it now costs at least $270,000 all-in for an out-of-state student today. Earning a 6X return on my investment 24 years later is a healthy 12% compound annual return.

And if you have a spouse who also has a college degree, your household net worth goes up even further! I hope after reading this article, all of you with college degrees feel much richer.

If you want an easy way to keep boosting your net worth, keep reading books. Every book you finish adds to your net worth by at least the cost of the book. Some books, like Buy This, Not That, will give you actionable advice that could make you far wealthier than the average person over time.

Do not discount the value of your education. It’s worth more than you think!

Reader Questions And Suggestions

How much value do you assign to a college degree? If we assign values to non-tangible assets like stocks, why can’t we assign values to a college degree? Do you believe that people will only pay the college tuition and spend the time if they feel the return will be greater?

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