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May 14

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Sports cars, 3D televisions, and education

Sports cars and 3D televisions are unprofitable investments.  They cost money at the outset and keep draining cash thereafter.  So why would anyone want to invest in such things?  Easy: sports cars and TVs are more concerned with pleasure and satisfaction than they are with financial return.  Recognizing this, it seems odd to even characterize such spending as “an investment”.  Higher education, for many students, is no different.

Economists attempt to answer whether college is “worth it” by measuring its profitability.  A recent paper by Brookings concluded that education at a surprising number of colleges has negative return on investment (ROI).  It also concluded that return on investment is more likely to be negative for certain majors.  Surprising to no one, the humanities and arts majors tend to make less money than the engineering and business graduates.  More surprising, the would-be humanities majors and others could be better off financially if they skip college and go straight to work.

Yet much research on this topic misses the boat in a big way by giving only a brief nod to the fact that a student’s primary motivation for pursuing a university degree might be something other than pure financial return.  This may be especially true of students in the low and negative ROI majors.  Is the philosophy student with no plans for law school really concerned about strict financial return on investment?  College for many students, and whatever the major, is about parties.  For others, it’s about becoming educated for education’s sake.  It might be a matter of cultural refinement or the chance to associate with similarly situated people.

Even in cases where college enables a particular career, happiness and pleasure may still be the primary motivator.  This could be true of teachers and college professors who might realize greater total financial wealth in an alternative career as mediocre electricians, plumbers, or small business owners.  It also may be true of accomplished musicians who are accepted to Juilliard.  The musician could likely realize more financial wealth by waiting tables instead of paying Juilliard’s $35,000 per year tuition and then trying to make money playing the cello.  Music school, like many college experiences, is less about financial return and more about realizing a dream.  Such people believe they will derive more total satisfaction from becoming a teacher or a musician, even if their chosen profession isn’t their most profitable option.

This isn’t true of lower-paying professions only.  The same could also be true of the bright and motivated student who realizes a dream of becoming an attorney, but could have realized more wealth by skipping college and law school altogether and becoming an entrepreneur instead.  Realization of a professional dream, even though it is centrally related to making money, may be justified more by the dream than by the money.

In many cases, the student’s wonder regarding financial return never arises in the first place.  This is common when others (e.g. the parents) are footing the bill.  For parents of such students, the answer regarding financial return-on-investment is much simpler and universal, even if less satisfying.  Unless parents can successfully tax their children, the investment is a lost cause whether their child majors in Greek Studies or Engineering.  College gets their kid out of the house and, with a little luck, affords the parents bragging rights: “My son has been studying philosophy at Brown.”  But bragging rights and getting the kid out of the house fail to increase the parents’ wealth either today or in the future.  Footing the bill is ultimately motivated by the pleasure and satisfaction of having provided a child with a gift, not financial return.

For the parents who would gladly continue funding their child’s lifestyle absent the child’s ability to do so on his own, the answer might be different.  But not necessarily so.  The would-be financiers could give their child cash instead of tuition.  With regard to some majors and some schools, the child with cash from Mom and Dad and no college education may be financially better off than the child with the college education and no cash.

Parents may be tempted to shore up assurance that children will be better able to care for them in their old age if their children are college educated.  But this too remains a hope dashed by negative net present values. The parents are most likely better off financially if they invest the would-be college expenses in a diversified portfolio of stocks and bonds.  This portfolio will likely do the better job of caring for them in their later years.

Recognizing instances where college education is a luxury good, and not a financial investment, has practical implications.  Foremost, college should not be treated as a necessity any more so than the sports car or the 3D television.  The prospective student and his parents need to perform the math and ask the hard questions.  First, is this college education intended to be a financial investment or a luxury good?  If it is intended as an investment, will it be profitable?  If the undertaking is not profitable, does it yield sufficient non-financial returns to justify the shortfall?  If all the answers come up “no”, recognize it as an overpriced sports car, and put your money elsewhere.

 

About the author

Eric Madsen

Mr. Madsen is a Chartered Financial Analyst (CFA) charterholder and a Manager at Fulcrum Inquiry, a finance and economics consulting firm that performs economic damages analysis involving commercial litigation, financial investigations, business valuations, and forensic accounting. He also holds an MBA from the UCLA Anderson School of Management and a B.S. in Economics. He conducts expert analysis in finance and economics. Mr. Madsen may be contacted at 213.787.4122 or at emadsen@fulcrum.com.

Permanent link to this article: http://betweenthenumbers.net/2013/05/sports-cars-3d-televisions-and-education/

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