The Law of Diminishing Returns is a nasty little ordinance…and few aspects of life escape its tyranny.
A short list of exceptions would include sex and world peace…or at least world peace. (To be sure about sex, a poll of long-married couples might be necessary). Suffice to say that this Law wields more power over life than any formal statute in the US penal code.
For proof of this fact, consider the lamentable condition of “the college education.” Once upon a time, a college education in America was a one-way ticket to a high-paying job and a lofty socio-economic status. Part of its value derived from the fact that a college education was relatively rare. In 1950, only about 5% of all Americans held a bachelor’s degree.
Since this 5% tended to fare so much better than the rest of the American population, lots of folks began to ask themselves, “Why not send as many kids as possible to college?”
This simple question sparked what would become a massive “college bubble.” This simple question spawned myriad scholarship programs, a college-construction boom…and Sallie Mae – née the Student Loan Marketing Association in 1972.
Today, more than 25% of Americans hold a bachelor’s degree – five times more than in 1950. But guess what? A bachelor’s degree ain’t what it used to be. The Law of Diminishing Returns is having its way.
According to the National Association of Colleges and Employers, more than half of all 2007 college graduates who had applied for a job had received an offer by Graduation Day. In 2008, that percentage tumbled to 26%, and to less than 20% last year. Statistics like these do not inspire confidence in a college degree.
More and more Americans have Alma Maters for which to cheer; but fewer and fewer have employment prospects worth cheering about. While it’s true that a college degree tends to correlate with a relatively high income, the nearby chart clearly shows that this relative high is drifting lower. During the last eight to ten years, the median income of highly educated Americans has been declining.
These statistics are troubling, even before examining their price tag. And what a price tag it is! The average annual tuition (plus expenses) at a private nonprofit four-year college is about $35,000. That’s $140,000 for four years – or just a little bit less than the median cost of an American home. How did prices ever get this crazy?
Thank Sallie Mae – vendor extraordinaire of student loans. Thanks to Sallie, and the industry she pioneered, most of the nation’s college graduates now possess far more debt than opportunity. According to FinAid.org, the total amount of money Americans have borrowed on government and private student loans at $830 billion has surpassed the total American consumer balance on credit cards, only $827 billion. But the problems wrought by Sallie Mae are far more pervasive and insidious than mere indebtedness.
Were it not for Sallie Mae, aspiring college graduates could never have borrowed far more money than they could ever hope to repay; universities could never have begun to believe that they are worth what they charge; professors could never have obtained their coddled lifestyles and the cost of a college education could never have appreciated well beyond any connection to its true economic value.
And herein lies the dirty little truth about an advanced degree – it doesn’t always do much advancing.
“Sometimes things we believe for good reason our whole lives turn out one day to no longer be true, because circumstances have changed,” writes Jack Hough in a delightful little article for SmartMoney. “Consider two childhood friends, Ernie and Bill. Hard workers with helpful families, each saves exactly $16,594 for college. Ernie doesn’t get accepted to a school he likes. Instead, he starts work at 18 and invests his college savings in a mutual fund that tracks the broad stock market.
“Throughout his life,” Hough continues, “Ernie makes average yearly pay for a high school graduate with no college, starting at $15,901 after taxes and peaking at $32,538. Each month, he adds to his stock fund 5% of his after-tax income, close to the nation’s current savings rate. It returns 8% a year, typical for stock investors.
“Bill has a typical college experience. He gets into a public college and after two years transfers to a private one. He spends $49,286 on tuition and required fees, the average for such a track. I’m not counting room and board, since Bill must pay for his keep whether he goes to college or not. Bill gets average-size grants, adjusted for average probabilities of receiving them, and so pays $34,044 for college.
“He leaves school with an average-size student loan and a good interest rate: $17,450 at 5%. The $16,594 he has saved for college, you see, is precisely enough to pay what his loans don’t cover.
“Bill will have higher pay than Ernie his whole life,” Hough relates, “starting at $23,505 after taxes and peaking at $56,808. Like Ernie, he sets aside 5%. At that rate, it will take him 12 years to pay off his loan. Debt-free at 34, he starts adding to the same index fund as Ernie, making bigger monthly contributions with his higher pay. But when the two reunite at 65 for a retirement party, Ernie will have grown his savings to nearly $1.3 million. Bill will have less than a third of that.
“How can that be?” Hough asks rhetorically. “College degrees bring higher income, but at today’s cost they can’t make up the savings they consume and the debt they add early in the life of a typical student. While Ernie was busy earning, Bill got stuck under his bill.”
“The great enemy of the truth,” John F. Kennedy declared in a 1962 commencement address at Yale University, “is very often not the lie – deliberate, contrived and dishonest – but the myth – persistent, persuasive and unrealistic.”
Fifty years later, a Yale education, itself, may be one small part of a vast American myth. Send your kids to Yale if you want; but don’t be surprised if the grads over at New Haven High are faring better financially a few years from now.
As a well-heeled acquaintance from Manhattan quipped recently, “Hey it’s gonna cost me $250,000 to send my kid to an Ivy League school. I’d rather just use the money to buy him a business, and let him figure it out in the real world.”
The logic is compelling.
Eric Fryfor The Daily Reckoning
Eric J. Fry, Agora Financial's Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
The assumed 8% return on Ernie’s mutual funds is something out of the handbook of bubble economics. That’s not to say that the articles general conclusion isn’t correct; –most surely it is. But suggesting that Ernie can out-save his more educated pal and come out ahead by a factor of 3 at retirement is way way off the mark. Chances are, the first time Ernie (or anyone in his family) gets sick, he will discover that the job he qualified for with only a HS dipolma has real crappy benefits, and medical costs will wipe-out all of his savings. Unless, of course, Ernie has put all of his savings into gold, buried out of the reach of his creditors.
“It returns 8% a year, typical for stock investors.”
Who? What? Where?
One main reason it seems as though the value of a college degree is decreasing, is the myth that a college degree is a college degree, and that they are all equal. This fantasy is pushed everywhere. From counselors who claim that a community college is as good as any private school education (for the first two years) and that these private schools will welcome community college transfers with open arms, to the schools themselves who offer degrees in art appreciation and computer science as if they were equal.
If you look within these statistics, you will find that a degree from an Ivy League school has retained its value pretty well, and that a degree in electrical engineering still pays better than one in sociology.
Every myth arises to cope with conditions of time and place.
The need is for a new myth, or the resurection of an old one.
what if bill pays more than 5% to pay off his college debt? his debt will be paid off much sooner ie (23 505-17 450 = 6 055 per year to pay down his college debt)
so Bill can pay off his debt in 3 years and start saving much sooner than the 12 years you stated.
I haven’t crunched the numbers but this will have a significant impact.
Fortunately the Department of Education continues to provide a significant level of financial aid to students who really need it, such as the Pell Grant Program.
The downside is that as many of you alluded to earlier, this federal aid is sometimes simply not enough, and students are faced with taking out a tremendous level of private debt that can really put them behind the eight ball once they graduate.
In my opinion it ultimately comes down to what you do with your degree once you graduate, although I do concur that some degrees are of course better than others.
Federal student consolidated loans and personal pupil consolidated loans both require a information of the current interest rates, variable rate of interest terms, and the present market. This is because every loan has particular interest rate terms.
It’s sad to say, but kids are graduating college these days with thousands upon thousands of college debt and they either can’t find a job or the ones that are available are for 30k/year.
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