One of the most important financial decisions people make is whether to go to college. The price tag of a college education is rising, but so are the benefits. In this lesson, you will begin by learning about the relationship between level of education and the average unemployment rate; and level of education and median weekly income; financing options for college; the importance of filling out the Free Application for Federal Student Aid (FAFSA); and finally, college as an investment in human capital, examine the costs and benefits, and decide whether it is a good choice.
In this lesson, you will learn to think about education as an investment in human capital. You will examine economic data showing how education is relates to unemployment and income. Next, you will discuss the Free Application for Federal Student Aid (FAFSA) and its importance to the financial aid process. You will learn about wage premiums and investigate the various college options available to students. Finally, you will read a short essay describing the financial costs and benefits of a college education.
Investing in Education
Are you planning to go to college? What are the costs and benefits of college? Cost/benefit analysis is the process of examining the advantages (benefits) and disadvantages (costs) of each available alternative in arriving at a decision. The price tag of a college education keeps climbing higher every year. In fact, the price of a college education is climbing at a faster rate than the average price level of other goods and services. So, is a college education is really worth the price? In other words, do the costs outweigh the benefits?
Economists think of a college education as an investment in human capital. They define human capital as the knowledge and skills that people obtain through education, experience, and training.
To learn more about human capital, view this video: www.econedlink.org/interactives/index.php?iid=230&type=student
Investment requires a person to pay for something now with the expectation that they will reap benefits in the future that make the investment worthwhile. In the case of a financial investment, this might mean buying stocks or bonds now with the hopes that the dividends, interest, and capital gains from the sale of the stock or bond, compensate for the risk that the asset might lose value. A business invests when they buy a piece of equipment or new technology with the expectation that the new equipment will increase the productivity of the business and increase profits in the future. In each of these cases, there is an up-front investment, with the hopes of higher income in the future. Investing in higher education is similar. It is an investment with the expectation that a higher future income will compensate the investor -- the student in this case -- for their risk.
Examine the following data which shows the unemployment rate for college graduates (blue) and the graduation rate for high school graduates (red): research.stlouisfed.org/fredgraph.png?g=73B
What is the relationship between level of education and average unemployment rate?
Examine the following data from the Bureau of Labor Statistics: bls.gov/emp/ep_chart_001.htm
What is the relationship between level of education and median weekly income?
This financial return on investment in education is often described by economists as a wage premium, and is calculated as the ratio of the median wage of those with a bachelor’s degree to the wage of those who have only completed high school. Over time the premium has risen, from a 40 premium in the late 1970s and early 1980s to about 80 percent in more recent times. This means that a current college graduate will earn, on average, about 80 more than those with only a high school diploma. It is important to realize that 80 percent is an average, and that different college majors have different return on investment. For example, engineering majors have the highest four-year premium at 125 percent, while psychology and social work majors have the lowest premium at 40 percent.
For a more detailed explanation of the college wage premium read this article (optional): https://www.clevelandfed.org/Newsroom%20and%20Events/Publications/Economic%20Commentary/2012/2012-10%20The%20College%20Wage%20Premium
Spending four or five years in college in your late teens and early twenties will likely yield a higher income for the next forty to fifty years of work. Over that length of time, the return on investment can be huge.
Paying for College
There are many ways students pay for college. Saving for college by students and parents should be a part of the equation, but often it is not enough. Part of considering the costs of college is applying for financial aid. The Free Application of Federal Student Aid (known as FAFSA) is used to determine eligibility for student financial aid including grants, loans, and work study. In fact, it is used to help determine eligibility not only for Federal programs, but for state aid and institutional (college or university- level) aid. The U.S. Department of Education begins accepting applications beginning January 1 of each year.
Click the link below to view a simulated chat, and then answer the questions below.. Once the pop up window appears, you will need to click “messages” for the simulation to start. You will need to click “send” after each message from Buck to see the entire chat.
When you finished the chat, answer the following questions:
How important is the FAFSA to eligibility for college funding?
What is the difference between a loan and a grant?
What is the difference between a subsidized and unsubsidized loan?
Why would the government want to know the income and net worth of your parents?
What is EFC?
- Are there deadlines associated with the forms?
Choosing a College
There are a variety of education options available to students including four-year public and private universities and colleges, and two-year community and technical colleges. You can reduce the financial cost of college by attending a local two-year community college and then transferring to a four year institution, living at home to save on living expenses, or paying for college while you are working.
Explore information on colleges including programs, tuition, and financial aid, use the college navigator found here: nces.ed.gov/collegenavigator/
Use the college navigator to search for estimated costs of community colleges in your area. Enter your zip code and a distance, say 50 miles. In the level of award section, check “Associate’s” (a two-year degree). In institution type, check “public.” Select a college in your area. Select the heading “tuition, fees, and estimated students expenses” and scroll to “multiyear tuition calculator” and click the “calculate tuition” button. Take note of the estimated cost, noticing the difference between in-state and out-of-state costs. Remember that in many cases, an associate’s degree can be transferred to a four-year university to reduce the total cost of your education.
Next, use the college navigator to search for estimated costs at public four-year institutions in your area. Enter your zip code and a distance, say 50 miles. In the level of award section, check “Bachelor’s.” In institution type, check “public” and “four-year.” Select a college in your area. Select the heading “tuition, fees, and estimated students expenses” and scroll to “multiyear tuition calculator” and click the “calculate tuition” button. Take note of the estimated cost, noticing the difference between in-state and out-of-state costs.
Finally, use the college navigator to search for estimated costs at private four-year institutions in your area. Enter your zip code and a distance, say 50 miles. In the level of award section, check “Bachelor’s.” In institution type, check “private” and “four-year.” Select a college in your area. Select the heading “tuition, fees, and estimated students expenses” and scroll to “multiyear tuition calculator” and click the “calculate tuition” button. Take note of the estimated cost.
Write a short summary of the difference in college costs among the various types of institutions.
- Remember that this estimate does not include room, board, books, or supplies. Also remember that the estimate does not include any scholarships or grants for which you might qualify for. When looking at public institutions remember to notice the difference between in-state and out-of-state costs. For example, if you are a citizen of Minnesota, you will be charged a lower rate at the University of Minnesota than a citizen of another state (unless there is a reciprocity agreement between the states).
As with any investment, you should be mindful of the relationship between the value invested and the expected future income, especially if it requires student loans. So, attending an extremely expensive university which results in high levels of debt for a degree with a low wage premium may not be wise. Instead, it might be wise to attend a community college or a state university to pursue that degree. On the other hand, attending a more expensive private university to earn a degree with a high wage premium might justify a higher level of debt. A common “rule of thumb” is that students should not borrow more than the first year average salary of people in that occupation. Using this guideline would mean that students would be justified in taking more debt to pursue a degree in engineering than in social work.
To examine current average wages for many occupations, look for the annual mean (average) wage of several occupations you have an interest in:
If you are not sure what occupation you would like to pursue, start here: www.bls.gov/k12/
Note that the rule of thumb is for starting wages and data provided is annual mean (average) wage.
One of the most important personal finance decisions you will make will be the decision regarding your education. The costs of college have been rising, but so have the benefits. You should consider the differences in costs of various types of college and universities, and the differences in income levels associated with different majors. One way to reduce the price of college is by applying for financial aid using the FAFSA form. Thinking about these decisions now can have a huge payoff in the future.
Read, Is a College Cap and Gown a Financial Ball and Chain? and answer the questions that follow.
With your family:
Discuss what you occupation you would like pursue.
Investigate what type of education and training will prepare you for that occupation.
Discuss what colleges or universities you would like to attend.
Discuss how you will pay for college.