Makin' Money

The best single investment

Chris Farrell Jan 11, 2012

A fierce debate has erupted in America over the value of a college education. Critics charge that a college education is an overpriced credential. Now, there’s no question that the household economics of earning a college degree are daunting. Students and their parents are borrowing a lot of money to pay for college, even as the wages of young colleges graduates decline.

That said, I don’t think the right lesson is to avoid getting a college sheepskin.  Sure, the incomes of young college graduates are down, but they’ve cratered for less-educated workers in recent decades. The average recent college graduate earns about 70 percent more than the typical high school graduate. About three-quarters of jobs require some form of post-secondary education — with more than half of those jobs for workers with a B.A. or higher. The unemployment rate of college graduates is far lower than their high-school-only and less-than-high-school peers.

Instead, students and their parents need to work very hard at avoiding taking on too much debt to earn a college diploma. Shop around for the best possible deal.  Debt-reducing strategies include going to a community college first and finishing up at a university; accepting admission to an in-state school rather than an out-of-state rival; negotiating for a better aid package from independent colleges; and similar money savings initiatives.  (The current debt-based financial aid system is unsustainable. But it will take major public policy initiatives to change the way students finance their education. It’s striking that, as late as 1993, most undergraduates didn’t borrow for college. Two-thirds borrow today.) 

What’s often underappreciated in the “worth-of-college” debate is that it’s a riskier investment than it appears. It’s a point I made at a session during the College Board conference on Embracing the New Normal in Newport Beach, Calif., Jan. 7-9. For instance, Michael Greenstone and Adam Looney of the Brookings Institution, in Where is the Best Place to Invest $102,000 — In Stocks, Bonds, or a College Degree?, estimate the return on investing in college is 15.2 percent a year. That’s more than double the average return in the stock market of 6.8 percent over the past 60 years (and a miserly 0.4 percent return on housing).

Return on Investment

Yet it’s an axiom of modern finance that the only way to create an opportunity to earn a higher return is to take greater risks. Put somewhat differently, the high average return on a college education masks a great deal of variability in the earnings outcomes among college graduates. (Has the stock portion of your 401(k) returned an average of 6.8 percent over the past decade?)

How many 18- to 21-year-olds really know what they want to do when they graduate? They could end up in a low-paying career. They could graduate during an economic bust. Jobs and careers are volatile in a hyper-competitive global economy. A college degree remains the ticket into a middle class job and career (and that’s before including any valuable knowledge and learning intangibles). I just wouldn’t borrow too much to own the ticket.

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