So what exactly is this buzzword, Return on Investment
(ROI)? Put simply, it is a measure of
what you get for what you put in.
Suppose you invest $1,000 in a bank that promises you $1,020
at the end of one year and an alarm clock, simply for opening an account with
the bank. You check online and see that
the value of the clock is $15. Your
return would then be $20 + $15 = $35 on a $1,000 investment, a 3.50% return.
It is clear that there are essentially two quantities which
determine your ROI. What you put in or
the cost. And then, what you get for what you put in,
or the return. Dividing the return by the cost gives you the
rate of return.
Common sense tells us that to increase the ROI, one must
somehow lower the cost, or increase the return, or do both.
Returning to the bank example, if a second bank, say Bank B,
offered you the same deal  $20 at the end of the year and an alarm clock  for
an investment of only $750, your gut would tell you to choose this bank, other
things being equal. And you would be
mathematically right  because this bank’s return would be $35 on a $750
investment, a 4.66% ROI.
If another bank, say Bank C, offered you a deal  $30 plus
an alarm clock  for a $1,000 investment, the return compared to the first bank
would be $30+15 = $45, or a 4.50% ROI.
But it would still be lower than that of Bank B’s.
Calculating the ROI for college follows the same method
except that you have to figure in what economists call Opportunity Cost. It is
simply an estimate of how much you benefit over a particular period  say, a
lifetime of work  for what you put in to attend college.
Clearly, the first and easiest step is to figure out how
much it will cost to attend college. Few
people have already saved up all the money it takes to go to college, so you will
probably have to estimate the total loan you will have to take, including
interest. Taking out a loan will
naturally add to the cost of attendance.
Second, figure out the opportunity cost  that is, how much
money you would notionally lose had you worked at a job instead of going to
college. Here, an important element is
how long you will take to earn your degree.
The longer it takes, the more expensive college becomes. After all, time is money.
Third, calculate how much money you would make after
graduation.
Finally, using a familiar financial analysis technique
called Net Present Value, you compute the total earnings after adjusting for
the total cost of college attendance, the interest on the loan and opportunity
costs. Believe it or not, the entire
problem can be brought down to a single number.
The cost of attendance
The easiest thing to do is to calculate the cost. US colleges go to great lengths at publishing
what it would take to attend their institution.
While grants, scholarships and other forms of financial aid information
are not specific to you until you apply, the costs are fairly generic and
easily available.
At Texas A&M University (TAMU), one of the best public
universities in the country, the total “Sticker Price” cost of attendance (tuition,
fees, living) for a Texas resident for a year (Fall & Spring semesters) is
$24,024. If you graduate in 4 years, the
cost of college will add up to $96,096.
Sticker
Price against Net Price
Just like buyers of cars never
really pay sticker price and are able to negotiate a lower price before
driving them out of a dealer’s lot, most families rarely pay the sticker
price listed on a college website.
The net price of attending college
is highly tailored to an individual’s situation and considers a variety of
factors unrelated to the merit of the student  such as if parents are
unmarried, divorced or separated; the number of children in college; the size
of the household; family income, savings and commitments, such as alimony;
family debt; willingness of students to work in the summer or during term and
so on. Colleges and universities quote
their net price estimates based on this information.
Two students with identical
academic accomplishments can therefore be offered entirely different net
price estimates from the same school.
The College
Board reminds us: “It is possible that your net cost will be lower at a
college with a high sticker price or higher at a college with a lower sticker
price. You may find that some colleges you thought were financially out of
your reach may be very affordable.”
Throughout this book, we use the
“sticker price” to model all of our calculations recognizing that for most
families, the “net price”, being lower, will likely bring these very
calculations more in their favor.
To estimate net price, visit your
desired school’s website and be prepared to spend 2030 minutes to answer
many questions about your situation to get the most accurate estimate. Or you could go to the onestop
site of the College Board’s and do the same for the many participating
colleges on the site. Another net
price estimator site is run by College
Abacus, which claims that nearly 5,000 colleges participate.

Assume that you borrow $80,000 to attend TAMU at an interest
rate of 6.80%. That is, you are able to somehow corral
$16,000 in cash from family and friends so that your loan amount is slightly
lower than the actual cost of attendance.
Suppose that, on graduating after 4 years, you earn a nice job paying $41,000
a year. Because you are a college
graduate, we will assume that you will get 5% annual raises throughout your
career.
Now that you have begun earning, you will have to start
paying your loan off. Education loans
don’t require any collateral  that is, they don’t require your parents or
others, with income, to cosign for you should you default. According to federal law, education loans
have to be disbursed solely on the student’s future ability to pay. In return
for this benefit, federal law is very strict about the student’s obligation to repay. In most cases, education loans cannot be discharged
even in personal bankruptcy.
Suppose you commit to a payment of about $700 a month
towards the loan. How long do you think
it will take for you to pay your loan off?
The answer: A very long, 15 years. And you would have paid a whopping $47,826 in
interest alone  more than half of the amount you borrowed. [Model these
numbers into an online
loan calculator such as the one from Wells Fargo]. It is little wonder that the financial
services industry is doing so well. The
total of principal and interest over the course of the loan will be a whopping $127,826. As we said, going to college is expensive.
The opportunity cost
This too is relatively easy to calculate. Remember that the opportunity cost is simply
the money you would have made had you worked at a job instead of going to
college. Suppose that upon graduation
from high school, a friend of yours who chose not to go to college but has
similar skills got a job as a telecom technician for a cable company and makes
$13 an hour. Assuming a 3% raise each
year, your friend would have made $26,000; $26,780; $27,583 and $28,411 during
the four years you would be at college, a sum of $108,774. Some may question the raise assumption but
experience has shown that whatever may be the individual numbers, college
graduates typically do get better raises.
It is important that the day you graduate, you would be $16,000+
$80,000 + $47,826 + $108,774 = $252,600 “in the hole”. This amount reflects not only what you spent
to graduate from TAMU in 4 years (down
payment towards fees plus principal
plus interest), it also represents
the opportunity cost  that is, what you could have earned had you chosen to go
the route of your telecom technician friend.
Technically, the $47,826 you pay in interest is over 15 years and we
will model it as such shortly.
Notice how the four year graduation rate is critical. If you took six years to graduate from TAMU,
even assuming that you didn’t pay anything extra in tuition, you would have
paid an extra $29,000 to live on campus  so we need to add this to the
original loan amount. Your new loan
amount will now be $80,000 + $29,000 = $109,000. Paying $832 a month, you will need 20 years to
pay off your loan. And you would have
lost $29,263 +$30,141 that your friend will have earned in years 5 and 6. The net result is that you would be $383,858 in
the red at graduation.
Unfortunately, the graduation rates at US colleges are
poor. According to the US Department of
Education, the average sixyear
graduation rate for firsttime, fulltime students who began seeking a
bachelor's degree in 2007 is just 59%.
Earnings Table
The fun begins when you start earning after your 4year
graduation. Look at the adjoining
table. At the same time your friend made
$29,263, in year 5, you would start off making $41,000 a year. Ten years after you graduate (year 15), you
would be making $66,785 but your friend, only, $39,327 (Column C).
But Column D is what really matters because this is the
amount left after you have paid out your education loan for the year (indicated
by the red boxes). The green box
represents the last year of your college loan after which you are free from
this burden.
Notice also that for the first several years after you
graduate, your telecom technician friend is doing well overall although your
earnings are higher. In fact, the
inflection point is in Year 15, a full 11 years after graduation. See Column E and the adjoining graph. At this point, your total cumulative earnings
are higher than your friend’s cumulative.
From this point on, your advantage over him widens. By Year 30, you would have earned $716,691
more than your HS friend.
Calculating ROI
Net Present Value (NPV) is a calculation that compares the
amount invested today to the present value of the future cash receipts from the
investment. It is a simple but powerful
approach to bring forward a series of cash flows each year to a single number,
a value in today’s dollars, eliminating the time component forever. NPV calculators are available online and as a
function in most spreadsheets.
An important quantity needed to calculate NPV is the
discount rate  the interest that takes into account not just the time value of
money, but also the risk or uncertainty of future cash flows. We are modeling two careers over a 30year
period, so it makes sense to use the 30year US Treasury Bill rate. Let us say this is 4%. Notice that we will be using the same
discount rate to model both careers.
Using NPV analysis,
the HS Grad income over 30 years equates to a single lump sum of $654,237 in
today’s dollars. What does this mean? Suppose this person had a wealthy parent who
gave him a gift of $654,237 for graduating from high school. He takes this gift to a local bank and buys
an annuity with an interest rate locked to the US Treasury Bill rate of
4%. Over the next 30 years, the bank
would pay him the same cash each year as his earnings working as a telecom
technician.
NPV analysis is valuable because it allows us to compare two
different sets of earnings over an extended period. In this example, your NPV as a TAMU grad for
the same 30year period with the same 4% interest rate would be $894,833. This number is 36.78% higher than the NPV of
your HS friend ($654,237).
Hence, your ROI for graduating from TAMU is 36.78%.
This hypothetical situation is much better than what the Federal
Reserve Bank of New York found in its study.
As mentioned in Chapter 1, the Fed said:
“An analysis of the economic returns to college since the 1970s
demonstrates that the benefits of both a bachelor’s degree and an associate’s
degree still tend to outweigh the costs, with both degrees earning a return of
about 15 percent over the past decade.”
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Our promise is to empower you with as much highquality, ethical and free advice as is possible via this website. But parents and students often ask us if they can engage with us for individual counseling sessions.
Individual counseling is part of the Premium Offering of Rao Advisors and involves a fee. Please contact us for more information.
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