The financial value of a university degree

This article by our CEO was originally published on SocialFinance.ca as part of a series of articles by the RBC Impact Entrepreneurs. The RBC impact entrepreneurs will compete in the Dragons Den competition at the Social Finance Forum in Toronto this year.

What factors determine the financial return of a university degree? - With the cost of university degrees rising much faster than inflation in North America and stories of graduates not earning enough to repay their student loans abounding, one can’t help but wonder: is higher education no longer the good investment it once was?

There are of course many non-financial reasons to pursue a degree. Higher education offers unique opportunities for learning new ways of thinking, exploring one’s interests, and socialization. Yet the fact remains that for many, higher education is seen as the pathway to more wealth. However, if one considers higher education through an economic lens, what determines whether a degree is financially worthwhile? There are more factors to consider than simply whether your wages will be sufficient to repay your student loans:

• The cost of the program, which consists not only of tuition fees, but also books, travel costs, student fees, etc.. Although this is the most straightforward factor, in most cases it is not the most important one.
• A much more influential yet often overlooked factor is foregone earnings. How much income is the person missing out on while studying and not working?
• The most important factor, and unfortunately the hardest to determine, is the increase in income the degree will provide.

Consider the following example which illustrates a hypothetical young person’s expected cash flow, based on program costs and expected earnings with and without a degree:

• Expected income with a university degree: Our student will not be earning a significant income during the first four years of our calculation while he/she is in university. From year 5 onwards, the graduate will earn an income that is higher than it would have been without a degree. Lets say the income will be $50,000 in year 5, $52,000 in year 6, $54,000 in year 7 etcetera. 
• Expected income without a university degree: If he or she decides not to attend university, an income will be earned from year 1. A typical income would be $30,000 in year 1. In year 2, the income will increase to $31,000. In year 3 to $32,000. In year 4 to $33,000 etcetera.
• Program costs (tuition and other study related expenses): The degree of our example student costs $30,000 per year in year 1-4.
• Positive/negative cashflow from the degree: The cashflow resulting from the decision of pursuing a degree = Expected income with a university degree - Expected income without a university degree - Program costs. In the case of our example, this results in a negative cashflow of -$60,000, -$61,000, -$62,000 and -$63,000 in year 1-4 from the costs of the program as well as foregone earnings while in university. After graduation, in year 5 and onwards, the cashflow turns positive from the increase in earnings: $16,000 in year 5, $17,000 in year 6, $18,000 in year 7 etcetera.

Looking at the numbers in the example above, the question is: if, instead of going to college, a young person would invest $60,000-$63,000 per year for 4 years, would that investment pay out more in the years 5 and onwards than the increase in earnings he or she would expect from the degree? If the answer were yes, then from an economic perspective, he or she would be financially better off investing in something else than in earning the university degree.

With this type of calculation, researchers have determined that the average ROI of a bachelor degree in developed countries is between 7.5% and 12.5%. However, especially if foregone earnings go up (i.e. you are already earning a good salary before going back to school and costs are high, think MBAs for example) this return can be significantly lower and even negative.

The amazing return on investment of higher education in developing countries - In the developed world, expected income with a degree is on average 1.5 times the expected income with just a high school diploma. However, in developing countries this multiplier is much higher. In Ghana for instance, expected income with a university degree is 4 times the high school graduate’s income.

At the same time, finding skilled employees consistently ranks among the top of challenges reported by employers in developing countries. As Ray Harraway, Human Capital Director at Ernst & Young Africa, puts is: “The demand for talent in Africa outstrips the supply. As a result of the higher demand for talent, the price of talent is going to go up and it is going to continue to go up for as long as there is a skills shortage.” The result is that in spite of high unemployment among local unschooled youth, companies in Africa continue to bring in Western expats at very high costs to run their plants, projects, wells and mines.

Despite the significant financial benefits, higher education is out of reach for the majority of high school graduates in developing countries simply because they are unable to pay for it. Scholarships and financial aid are grossly insufficient to meet the level of need. Banks do not give out student loans because uncertainty about inflation makes unsecured loans very risky from a banker’s perspective and/or unaffordable from a borrower’s perspective. The resulting imbalance in supply and demand is what drives these high income multipliers.

Brighter Investment helps students and investors capitalize on this labor market trend - The return from obtaining a university degree, while already very high in developing countries, is expected to increase even further in the near future. Technological developments in education are expected to make good universities more efficient educators, and labor market trends are expected to double the demand for talented graduates by 2025. From an economic and from a social perspective, we have to ensure that the good universities are accessible to the brightest students, irrespective of their family financials.

At Brighter Investment, we financially support students to obtain degrees that are in high demand in their country. In return, graduates repay a percentage of their future income back to our investors - a model that is less affected by inflation than a traditional student loan and ensures that students can always afford repayments. We make sure that we are always investing in those programs and students that excel at generating positive returns for both students and investors.  

Our program offers a pathway out of poverty for young people who would have no way of pursuing their ambitions without financial support. On top of the social impact, we offer our investors a competitive return. If you would like to learn more, contact us at inquiries@brighterinvestment.com,  or meet us at the Social Finance Forum November 12 and 13 in Toronto.

Article on SocialFinance.ca