My family recently faced a bit of drama when my daughter was accepted to both a great state school and a wonderful, but much more expensive, private school . Naturally, my daughter strongly preferred the latter. As a finance guy with what I’d like to think is a disciplined approach to decision-making, how could I possibly justify the price difference? Is it even possible to make a rational decision with my baby’s puppy dog eyes imploring me to support her choice?
I am not alone facing this conundrum. A recent study by Pew Research Center suggests that Americans are deeply ambivalent about the value of a college education. Only 40% of those surveyed thought the value received generally was excellent or good. On the other hand, 86% of college graduates thought their education was a good investment personally.
We attempted to decide rationally using cost-benefit analysis (CBA). CBA requires quantifying in dollar terms all of the costs and benefits, now and into the future—discounting future net benefits to today’s dollars. We compared the relative benefits, net of costs, of both alternatives, incorporating risks and uncertainties. These costs and benefits are not just financial, but also psychological, social and moral.
Clearly some costs and benefits are more easily quantifiable than others. Tuition, fees and books are pretty easy to forecast. The opportunity cost of foregone wages from going directly into the workforce, is also fairly easy to estimate. Benefits like improved future earnings are harder to quantify because they depend on the major she chooses, career choice and a thousand other variables.
The New York Fed found that the purely financial return on investment (ROI) for bachelors degrees remains strong, ranging between nine and twenty-one percent for education and engineering majors, respectively. However, calculations by payscale.com indicated returns of just six and two percent for the public and private colleges we considered. We can earn 3.09% by investing in nearly risk free US Treasury Bonds. Paternal affection aside, the bonds are a better investment than the private college.
Or are they? There are several hard-to-quantify and uncertain benefits to the more expensive school that are nevertheless relevant:
- Greater chance of academic success: greater support from staff and faculty, smaller class sizes and more robust services probably increase her chances of completing school on time and with better education. (Nationwide, only 40 percent finish school within four years, increasing the actual cost of the degree.)
- More fulfilling career: a potentially better educational outcome from a more prestigious brand-name college should give her more options to find a more rewarding (financial, social and otherwise) career path, potentially improving returns.
- Making my daughter happy: Need I say more?
Finally, our intuition is that the private college would give her a better start as an adult, citizen and participant in the human experience:
“Let’s keep in mind the real value and important outcome of a liberal arts education, which is not necessarily income, but self-discovery, acquisition of knowledge, and learning how to think critically so as to make valuable contributions to society.”
Philip D. Adams, Savannah State University
That said, let’s return to the financial returns: is this standard return on investment calculation misplaced here? From a self-centered perspective, it doesn’t make sense to include my daughter’s future earnings in the analysis at all. After all, she’ll keep and spend those dollars herself. Therefore, we parents get zero* financial benefit but bear all of the costs, making our ROI massively negative.
It’s only at the level of the family, where benefits to the child are included, that returns are (slightly positive). We could also perform the analysis at the level of society, which benefits from a potentially more productive taxpayer versus the additional cost of a somewhat less efficient delivery of higher education by having more professors per student.
At the end of the day, we decided to send our daughter to the more expensive school. We are grateful to the results of the ovarian lottery and some careful planning for making this option available. We incorporated benefits and costs, quantitative and qualitative in at least three frames of reference. Were we rational or just good at rationalizing?
*Maybe not quite zero. Perhaps going to a “better” college will reduce the chances that she will boomerang (live at home after college while looking for work).