Two readers recently asked me whether I thought taking out a student loan to get an education to increase one’s income would be a good idea. Is it reasonable to consider education an “investment”? Most people I know would say so and education is commonly always considered an investment in one’s future. Often some piece of statistics is presented that show a correlation between level of education and income I tend to disagree. Some educations are not very remunerative, nor are some students treating their “investment” as an opportunity to better their skills. But before I go off on a rant let me return to the point.

The question is whether an education can be valued as an investment in strictly monetary terms?

I will present a simple example. Suppose a person is currently earning \$30,000 a year, that the education will take two years where no income is earned and that it costs \$10,000 each year in cost of living and tuition. Also suppose that after the completion of the education, a salary of \$40,000 will be earned.

The cash flows look like this

 30000 -10000 30000 -10000 30000 40000 30000 40000 … …

Now, these cash flows must be discounted. The reason is that \$10,000 in one year is not worth the same as \$10,000 today. The reason is that you can invest \$10,000 today at 5%, for example, and have \$10,500 in a year. Consequently, \$10,000 today is worth \$10,500 in a year for a 5% discount rate or conversely, \$10,000 in a year is worth \$10,000/1.05 = \$9,523.81 today. Two years from now cashflows must be discounted by 1.05*1.05=1.1025, and three years, the discount is 1.05*1.05*1.05=1.157625 and so on.

These are divided into the table and we get

 30000 -10000 28571 -9524 27211 36281 25915 35554 … …

You may want to compensate for subsequent salary increases and the fact that you are not going to work forever. Now add up the columns. The greater number wins. If you subtract them, the difference is the monetary value of your education. You may want to play with the discount rate. 5% is quite conservative. 8% is more reasonable in today’s market environment, and 10-12% is quite optimistic.

A few observations: The longer your education, the worse you are off. Higher early expenses will be more costly than high later expenses e.g. a costly undergraduate degree followed by a master degree on a stipend. If the education leads to a job with higher hours/costs, you might want to divide that into the difference to get an idea of your hourly wage increase. It might be smaller than you think.

Have fun, and I’d love to see some numbers if anyone does the calculation.

Originally posted 2008-08-30 12:32:20.