Friday, March 10, 2006

Is an Education Worth the Expense?

Outside the improvements in self esteem, communication and analytical skills, an education boils down to return on investment. I risk making this post as exciting as a "Wonder Years Ben Stein Lecture," but here goes...

Do you think it will make you more competitive for promotions? Do you think that a new career field or higher education would give you enough of a marginal increase in salary to merit the time spent?

I'm a proponent of education. However, you must understand that it's important to monetize the worth of an education. You don't want to enroll in graduate programs online blindly thinking you'll get a pay raise. Here's some things to consider:

1. How much of a pay cut will you sustain over the period of pursuing an education? If you don't experience a salary decrease, do you think that your focus on an after hours education will impede your focus at work, thereby limiting promotion opportunities?
2. Once you graduate from a program, do you think you'll take a pay cut until you establish some form of seniority?
3. How long will you work in the new career field and benefit from the improved education?
The best thing to do, strictly from a monetary since, is to:

a) Monetize the net increase in salary that you expect over the remainder of your career: Present Value[ (new salary - prior salary)*(Number years remaining in work force)].
b) Monetize any impacts (decreases) to your annual salary while going to school
c) Monetize the cost of your psychic energy expended on school work. Could you have otherwise spent your psychic energy (brain power) teaching your children something useful or otherwise contribute to the household? This cost may be ignored, but you should be aware of it.

Now determine the net present value of a, b and c.

Example... If you make $90k/yr now and you pay $125k to go to med school and increase your salary to $200k/yr for a 15yr career as an M.D.

Benefit "A": ($200k - $90k) for 15 years @ 5% discount rate, Pay Raise Deferred Six Years From Now = $852,000.67

Cost "B": Lose $90/yr salary for six years @ 5% discount rate = -$456,812.29 (present value of unearned income b/c in Med School/Residency)

Cost "C": Ignored, but could be considered

Net Present Value of "A, B, C" = $852,000.67 - $456,812.29 = $395,188.38

Now determine your return on education: Return on education: [(Net Present Value A,B,C) – Education Cost]/Education Cost * 100 = ($395,188.38 - $125,000)/($125,000) * 100 = 216% return

Got a headache from all this? Don’t know how to determine Net Present Values (NPVs)? Don’t know how to use the five major keys of a financial calculator? I can try to help via email. If there’s a lot of questions, I’ll post some lessons on the blog.

It’s important to note that I simplified the discussion and calculations some for the sake of saving space.

By the way, I’m going to make some changes to this blog over the next two weeks to make the layout a bit more efficient.


Tim said...

Interesting way of looking at it. I'll be going from ~$1500 per month in income in a low paying job to about $6000+ per month when I graduate. I think the ROI is very, very good. :)

Good post.

Nathan Whitehead said...

One more thing you could add to the calculation: the psychic benefit of having more education. Many people like learning, and gladly pay to learn things that have no effect on their salaries.

Finance Junkie said...

Sounds great Tim!

Concur w/ Nathan.

I slightly sidestepped giving psychic benefits their just respect, perhaps in another post. The do tend to give you more intellectual horsepower.

I sidestepped (sort of) discussion of these other psychic benefits in the intro where I mentioned something like... besides increased communication and analytical skills...

It is assumed that many of these psychic benefits are directly compensated in higher salary levels, while the other psyhic benefits are predominately for self improvement.

1mill_by_35 said...

Great job, FJ! I did the same type of analysis before I went to school and now that I've graduated and actually know the results, I don't even try to calculate my ROI! I can say it was well worth it. One thing you might want to consider is the optionality an MBA creates (real options in finance I think it's called). You never want to assume you will make a seven or eight figure salary, but with an MBA or a JD, it definitely becomes possible with the right breaks in your career. You can never predict the future. Anyway, I'm going to link to your site in my blogroll and would be grateful if you added mine to your blogroll.

Finance Junkie said...

A gentleman who will remain anonymous left this comment (i'm moderating it):

Due to robotization, offshore outsourcing and major changes in technology that affect directly certain proffesions, this component of your equation: (Number years remaining in work force) has become almomst impossible to gauge. This in turn affects greatly the validity of the equation. I am posting an article in the blog about it soon.
Good post though!

Here's his post excluding the site he wanted to refer you to.