ROI of education

0:00- [Instructor] We're told that a four-year degree program costs $40,000 per year. Graduates earn $60,000 per year. Without the degree, the worker earns $30,000 per year. Assume there is no wage growth and no loan interest. What is the return on investment after working 10 years?

0:16So pause this video, have a go at that. Okay, so there's actually two ways you could think about this. We could do ROI from a cash point of view, and let me write that over here. If we're thinking purely about the cash, ROI is going to be equal to the net cash benefit, benefit, or maybe net cash return, you could also say, over total cash, cash investment.

0:48So if we think about it just from a cash point of view, what's our total cash investment? Well, the only money we're paying is 40,000 per year for four years, so 40,000 times four is $160,000. And now, what's our net cash benefit? Well, we are going to, in this scenario, we are going to be making $60,000 a year times 10 years.

1:14So you might say 600,000, but it's not like you would've made nothing had you not done the degree. So what you care about is how much more you're making. So this is plus $30,000 per year over 10 years, so you get that 300,000 benefit. But once again, you have to think about net of everything, including your cash costs.

1:39So it would be 300,000, so this net cash benefit would be the 300,000 wage, net wage benefit, minus the 160,000 that you had to put in to getting that net benefit. And so this would be equal to, in the numerator, we would have 140K, in the denominator, we have 160K.

2:04And if I get my calculator out, if I say this is going to be the same thing as, really, 14 divided by 16, I could just write 140 divided by 160 is equal to, and this is 0.875, which is 87.5%, and if I wanna round to the nearest whole number of percentage, that's approximately an 88% return.

2:34So this right over here is approximately 88%. Now, I said there's another way of thinking about it, and actually, the other way of thinking about it is how I would actually do it in my actual life. And here, I would think about all costs, all costs, and I guess you could say all benefits.

2:51Now, what do I mean by all costs? Well, our net cash benefit is still going to be, actually, no, no, let me be careful, 'cause I wanna think about net benefit after capturing all costs. So what's our total cost here? Let me put that in the denominator. It's going to be this $160,000, $160,000.

3:11But are there any other costs here? Well, if I take a four-year degree, that means I'm not working for those four years. I could have, if instead of doing that degree program, I could go and work and make $30,000 a year, so I really have an opportunity cost here of another $120,000, $30,000 a year for four years where I could be working instead of going to class and studying and taking tests, et cetera.

3:36So really, not only am I paying $160,000, but I'm foregoing $120,000 in wages. So that is $280,000 of total cost, I guess you could say, or total investment, and then what's our net? Well, there's a net that we just had. There was that 140K net cash benefit, but then, of course, we need to also subtract out our opportunity cost, so minus 120K.

4:08So here, we get 20K over 280 K, and if we look at it over here, and once again, this is over 10 years, we get 20 divided by 280, we get, rounded to the nearest percentage, about 7%. Now, there's a bunch of other stuff to think about here. This is a 10-year return, and if I told you you're only making 7% over 10 years, you might say, "Oh, that's not that great."

4:37But you also might wanna think about, this was only after 10 years of working. most people aren't just going to stop after 10 years. They might have a 30 or 40-year career, and the benefits are going to keep accruing longer and longer. So if this said 40 years or 50 years, it might be very different.

4:53Also, this assumption of no wage growth is really not as realistic. It's oftentimes the case that people who are entering a profession, not only do they have a higher starting salary, but the wages go up faster and actually go at a much, much higher levels while the person without the degree, sometimes they might just stay at a relatively low wage for a long time.

5:15So that's another thing to think about. Now, on the other hand, there's how do you pay for, if you're taking on a loan here, we don't really talk about whether you're paying it in cash, whether you had the money, whether you're borrowing it. If you were borrowing it, you would have to think about loan interest.

5:28If you wanted to complicate things more, and you would probably need a spreadsheet for this, you would also want to think about, well, what else could I have done with that money? I could have put it into the stock market. You could make assumptions about what type of return you could get.

5:41You could put it into a house as a down payment. Then you would have to think about what the interest rate is and what appreciation assumptions you would have to make. There's also the notion of time value of money that we're not factoring in. For example, a benefit of $30,000 per year, 10 years in the future, the present value of that, which we talk about in other videos, might not be $30,000.

6:02We're not really thinking about time value of money in this analysis. This was just a very straightforward, simplified analysis. So it could get a little bit more complicated. But the big takeaway is return on investment is net benefit divided by total investment, and you can think about whether we're only thinking about a cash point of view or whether we're thinking about all potential costs.