While financial advisors know that investing in equities has delivered an average rate of return of around 6.5% above inflation over the past century, they also understand that not every stock investor has realized those results.
Perhaps that well-understood divergence will help advisors appreciate another kind of investment with high average returns but disparate impacts on investors.
That investment is a college education, and a new study by researchers at the Federal Reserve Bank of New York, offers a nuanced view of the economic value of such an undertaking.
Going to college has become something of a hallowed and highly anticipated experience for young Americans, and debate over the value of a degree and the fortunes of the millennial generation has grown in intensity.
Analysts at PIMCO recently offered assurances that a degree is valuable and that millennials’ financial position will improve, which will in turn trigger pent-up demand for housing and housing-related assets that have been slow to recover following the real estate bust.
In contrast, PIMCO rival Jeffrey Gundlach of DoubleLine Capital has argued that the economy generally and housing particularly face structural headwinds that won’t be aided by the declining fortunes of millennials. “The kids aren’t all right,” he has warned.
Enter the New York Fed’s Jaison Abel and Richard Deitz. In their four-part series on the economics of a college degree, the duo acknowledge the headlines that make this issue so salient today.
Tuition costs have been rising faster than inflation, student deb is mounting, wages for college graduates are falling, and job prospects for graduates are weakening.
At the same time, the data show that the economic worth of a bachelor’s degree is near its all-time high of around $300,000, and the time required to recoup the costs of a degree — currently about 10 years — remains near its all-time low.
The reason they suggest for the degree’s high value? “The wages of high school graduates have also been falling,” thus maintaining the relative strength of the college wage premium.
However, Abel and Deitz keep their microscope on the data to examine another factor that is degrading the value of college for many millennials: namely, the extra time they spend at college beyond the four years assumed in the data adduced above.
They find that the worth of a bachelor’s degree declines considerably for those making college their home for five or six years.
It’s not merely, or mainly, the extra tuition and fees, which add on average net costs of about $6,500 a year. Rather, it is primarily the forgone earnings and the forgone experience that follows a late-graduating student throughout his lifetime.
“All in all,” the Fed duo find, “an extra year of staying in school costs more than $85,000, and for those who take two extra years to finish, it costs about $174,000.” On a net present value basis, using a 5% discount rate, each extra year in college subtracts $65,000 from a student’s lifetime earnings.
Viewed on a rate of return basis familiar to investment advisors, a college student currently averages a 14% rate of return on his education investment if the degree is obtained in four years, but for the large number of students taking longer, the return on investment is 11% for a five-year degree and 8% for a six-year bachelor’s. That two-year gap reduces the rate of return by 40%.
The authors point out that among those completing their degrees within six years, only two-thirds of them obtain their bachelor’s degree in four years or less, so the population thus degrading the economic value of their degrees is quite high.
The most startling finding of the Fed duo’s research, however, is that about a quarter of those who earn a bachelor’s degree reap little economic benefit.
Thus, despite the college wage premium that exists on average, a fourth of college graduates “eaern wages that are not materially different from those of the typical worker withi just a high school diploma; indeed, some “sizable share” earn less than those with mere high school diplomas.
And considering the degree’s costs, it is likely that a college education was “not…a good investment” for the lowest 25% of college graduate wage earners, Abel and Deitz write.
The final segment of their research, about college graduates’ job prospects, similarly adds little cheer for students currently making this large investment.
The good news is that unemployment for college graduates is currently falling and has improved since the ravages of the Great Recession. But underemployment — the inability to find work that makes use of a graduate’s degree — continues to rise.
Underemployment for recent graduates now stands at 46%, compared with 35% for college students generally.
That doesn’t mean that nearly half of college grads are working as waiters or retail clerks. A rising proportion are taking higher-wage non-college jobs such as dental hygienist, electrician or mechanic, the authors say.
But their analysis of recent data suggests to them that “from 2013 to mid-2014, job postings leveled off for college jobs, while they generally continued to increase for non-college jobs.”
In other words, there appears to be a decline in demand for college-educated workers in today’s economy, thus making it harder for graduates to find good jobs.
Consequently, while a college degree is beneficial, on average, compared with the alternative options, the Fed duo conclude that “the challenges recent graduates have faced in finding a good job might mean that a college degree will not be as lucrative as it once was,” and for some segment of the population it may prove a poor investment.
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