This article is about making the best college decision and being smart about college debt. We use The Stoic's Arbitrage as an approach to making high-value decisions. This approach may be helpful for many life decisions, especially for the college decision. In many cases, the college decision has become the single highest impact personal finance decision we make.
To begin with, student lending has become a BIG problem in the United States. Long-term student loan default rates are almost 20%, graduation rates are down, and college costs are way up. (Please see my article The College Decision: Proceed at your own risk for more information) Making the choice of going to college and which college to attend has become increasingly important to long-term financial health. As a former recruiting leader of a Big 4 firm, I do have a unique perspective about the value of college. To illustrate my perspective, the following is my typical Q&A exchange:
If I am asked the question: "What is the difference in value between a more expensive private college like Drexel and a less expensive in-state school like Virginia Tech?" [i]
My answer is simple: "About $200,000 to graduate and over $4 million for your retirement...that's it!"
The reason is straightforward. I simply cannot think of a good reason to pay more money for the same value. My Big 4 recruiting experience will help clarify my reasoning. Think of the Big 4 firms’ recruiting approach as a representative model for all industry recruiting. The Big 4 recruits highly capable college graduates, at scale, and across almost all business, STEM, and related disciplines. Here is the thing. The Big 4 recruits broadly, from big schools and small schools, public schools and private schools.
The Big 4 has figured out, 1) it is the individual student that matters, more so than the individual school and 2) no one school has a monopoly on high quality students. Said another way, all schools have a subset of good students, the hard part is identifying and recruiting them.
So the Big 4’s recruiting approach is to target colleges broadly and target high-quality students narrowly. In the case of the Drexel/Virginia Tech example, the Big 4 has a long history of recruiting excellent students from both schools. From this recruiter’s standpoint, other than price, there is no difference between the schools.
If you are choosing a school, my advice is:
Do not get too hung up on the college’s brand name,
Pick a state public school (or a school with the equivalent of or lower than in-state tuition), and
Pick a school you are committed to getting good grades.
College grades are an important recruiting signal suggesting readiness for the working world. Think of grades as the “3Cs” recruiting signal. That is, your grades signal recruiters the trinity of:
intellectual Competence → ability and willingness to learn
Conscientiousness → hard worker
Collaborativeness → team player
Said another way, if you are not ready to commit to getting good grades, do not waste your money. Just wait until you are ready! By the way, if you are not ready for a four-year college, I am a big fan of the community college system. Done appropriately, it can be a lower-cost way to build study habits and good grades, as preparation to transfer to an undergraduate institution. [ii] As further confirmation, research by Dale and Krueger suggest the return to selective colleges are insignificant across large groups. They determined this by controlling for those colleges applied to and accepted across a large group of high school college applicants, using long term earnings to measure performance of those different groups. As an exception, they did identify certain first-generation college cohorts as benefiting from selective colleges. This suggests the additional college resources provided to those with less family college experience have some benefit. [iii]
Now, let’s consider the stoic’s college arbitrage value, based on annual tuition, room, and board estimates:
The difference in total cost between the schools is $50k / year or $200k total for 4 years. Assume the difference is invested and is available for the student’s retirement at age 65 (graduate at 22, retire at 65). The future value at 7% (after-tax annual yield) available for retirement is $4,662,484! This means, choosing the more expensive school will cause you to forego a massive amount at retirement. Important to note: This calculation does not include student lending. Assuming a student loan is more likely needed for a more expensive school, the arbitrage opportunity could be significantly higher. [iv]
The U.S. Federal College Loan system obscures the difference between these 2 schools. They do this via our naturally occurring cognitive bias called “salience.” Salience occurs when people naturally pay more attention to what’s immediately in front of them. We are more likely to ignore a more significant but less visible future reality. [v] In this case, the U.S. Government enables students to attend either of these schools by immunizing the students from the immediate financial impact. This is done because each school has access to Federal student loans to offset their student’s short-term (more salient!) cost of education, regardless of the individual colleges' ultimate cost of education!
“Our student lending system is like a bamboo finger trap, easy to slide your fingers in, but hard to pull then out!”
In this case, the Federal student loan system will allow accepted students to finance the total cost of either the Drexel or VT education, net of their expected family contribution. Often, this includes delaying loan repayment until after they leave school. This occurs even though the long-term (less salient!) financial impacts are massively different between schools. In this example, the long-term difference is worth over $4.5 million! Caveat Emptor!
To help appreciate the impact of salience bias and other student loan idiosyncracies, please see our article The Road To Adsurdistan. This takes you on an imaginary home financing journey in the alternate world called “Absurdistan.”
To some degree, society makes the college decision more difficult than needed. The confusing decision dynamics are influenced by our desire to help our children, societal pressure, college recruiting professionals, college marketing, loan considerations, etc. Even former Maryland Governor and presidential candidate Martin O’Malley fell into financial difficulties because of his children’s college decisions. His experience is worth reading as a cautionary tale.
"We can second-guess the wisdom of the O'Malleys' decision, and I do. But now that they've made it, I hope the family given their public platform– will use their experience as a cautionary tale that, for most families, it's not okay to cave to an 18-year-old whose dreams of a particular college will create decades of debt."
College has become one of our most significant financial decisions. It seems unfair that the ultimate “beneficial owner” of this decision is often only 17 years old! It is up to you to build your own financial salience. Our current college lending system obscures the potential long-term financial risks.
This article provided a framework for 1) considering the long-term financial impacts, 2) considering your natural salience bias, and 3) using your college stoic’s knowledge to make a great college decision. As a college stoic, we do believe it is possible to avoid Absurdistan’s pitfalls.
Notes
[i] I picked Drexel and VA Tech as examples, but I could have used many others. I picked them because my kids and immediate family members considered both of them, but did not attend either of them. They are both excellent schools.
[ii] Hulett, Be like Rudy: Community College as a smart, lower-cost path for Higher Ed, 2021 and
[iii] Dale, Krueger, ESTIMATING THE RETURN TO COLLEGE SELECTIVITY OVER THE CAREER USING ADMINISTRATIVE EARNINGS DATA, National Bureau Of Economic Research, 2011
[iv] The tuition, room, and board amounts assume full payment is required. If scholarship or grants are provided, it is assumed each school and student has equal access so the comparative effect will net to 0. See my Stoics Arbitrage Models for assumptions and calculations.
[v] Thaler, Sunstein, Nudge, The Final Edition, 2021
This book provides a good explanation and other examples of “salience.”
In the case of student lending, related to salience is loss aversion. As Kahneman and Tversky describe in Prospect Theory, 1979, people naturally place more weight on losses than gains. In our student lending example, people lose nothing (I.e., no loan payments) in the first 4.5 years of a student loan, but gain a much smaller retirement in the future.
Further Reading:
Foundation
High School Students
College Students
10. College Success!
Career and Beyond