Warren Buffett remarked that, "It's only when the tide goes out that you learn who's been swimming naked.” It is the receding tide of employment that has exposed the next likely financial bubble: college debt.
Is It Worth It? One of the biggest expenses impacting the resources for your retirement is saving for your children’s college education. So, one of the important questions to ask is, is it worth it?
Much like housing, a college education has been considered a valuable asset whose worth should continue to rise. The economic value of a college education has been documented relative to a high school diploma. According to the Pew Research Center, the typical college graduate earns approximately $650,000 more than a high school graduate.
Harder Look: However, this is somewhat a disingenuous calculation. Let’s say you were to offer two potential C+ college students the following opportunity: 1) full financing of a private college education ($40,476 annually); or, 2) the equivalent lump sum of the college cost as an investment in lieu of a four year degree.
Let’s Assume the Following: 1) initial annual earnings of 25-to-29 college graduate $50,000 and $31,000 for a non-graduate; 2) annual earnings growth of 3% and 2% respectively; 3) a lump sum college cost investment growing at 5% annually. Based on a 40 year career window, this potential college student would be financially indifferent as each would generate a sum total of approximately $3.0 million over that period.
Sub-Optimal Circumstances: However, since 2000, the real cost of college is up by 23% while the real earnings of college graduates is down 11%. At the height of the economic cycle in 2006 and 2007, a college graduate had a 90% chance of being gainfully employed by the following spring. In 2010, the same odds were reduced to 56%, approximately a 40% decline. This inability to procure gainful employment has resulted in over 30% of the graduates living at home with an average of $27,000 in student loans which has translated into a rising loan default rate of 8.9%
Why It’s Personal: While we may shrug this off as too bad for them, it has financial implications for the taxpayers. U.S. student loan balances are now approaching $1 trillion with almost 40% being added since 2006. It now surpasses credit card debt totals and is second only to mortgages as consumer liabilities. Given 70% of student loans are government sponsored, this means like the banks, taxpayers are on the hook for non-payment — although, student loans aren’t forgiven in a personal bankruptcy … try collecting.
Is There a Bubble? The classic definition of a bubble is steadily increasing price in the face of declining values where the underlying assets are heavily leveraged — in this case with government supported loans. This certainly sounds very similar to conditions that pre-existed the housing collapse.
Leading Indicator: If you want to look at a good leading indicator, you can look at the for-profit college sector. Almost half of the federal student loans made to such institutions such as Apollo (APOL), DeVry (DV), Strayer (STRA), etc., will end up in default. This has generated the “gainful employment rule” by the Department of Education regarding the ability to repay loans. In many cases the student loans couldn’t be justified relative to compensation received once graduated.
The following is a chart of the S&P Education Service Sub Industry Index (S15EDSV-IND) versus the S&P 500 ETF (SPY).
A Thought to Ponder: The average net worth of billionaires who dropped out of college is $9.4 billion versus $3.2 billion for PhD billionaires. Remember, great wealth is created by new ideas and bold personalities — not docile technocrats who do well in a structured learning situation. Even if you remove Bill Gates, one of the world's richest man, who left Harvard University, and is now worth $59.0 billion, the average college dropout is worth $5.3 billion on average, compared to those who finished only bachelor's degrees, who are worth $2.9 billion.
Accumulation of Knowledge: The reason why there is so much knowledge in universities is that freshmen bring very little in and seniors take little out. So, it just accumulates there.
While this commentary may sound anti-educational, it’s not. Learning is not the only province of colleges. As Mark Twain commented, “I never let schooling get in the way of my education.”