Human Capital
Many of you have already decided on your first big investment - YOU. The money you spend on your college education is an investment - an investment in human capital which we will talk about in the input section of the microeconomics course - and you should expect a decent return on that investment. For the sake of simplicity, let's assume a college education costs $100,000 payable today. You are investing $100,000 today to earn more in the future. Where does the return on the investment come from? It comes from the higher earnings college educated individuals make over their lifetime. Again for the sake of simplicity, let's assume the college grad earns $20,000 a year more than the high school grad and that she will work for forty years. The Current value column shows the $20,000 a year differential so that over 40 years the college grad would earn an extra $800,000. The Future value column gives you the earnings differential if we assume there will be 2 percent a year growth in the earnings. In this case the lifetime earnings will be $1,208,040 higher.
Before we look at the return on the investment we need to acknowledge the fact that a $ today is not equal to a $ a year from now and we need to use present value analysis to convert the future values into their present values - the numbers that appear in the last column. To earn an extra $43,295 forty years from now you would invest $6,457 today if you expected to be able to earn 5% on any money you invested. Stated a bit differently, if you invested $6,457 now at 5% a year, in forty years that sum would have grown to $43,295.
Value of a College Education
Years |
Current value |
Future value |
Present value |
1 |
$20,000 |
$20,000 |
$20,000 |
2 |
$20,000 |
$20,400 |
$19,429 |
3 |
$20,000 |
$20,808 |
$18,873 |
…. |
|||
38 |
$20,000 |
$41,614 |
$6,843 |
39 |
$20,000 |
$42,446 |
$6,647 |
40 |
$20,000 |
$43,295 |
$6,457 |
| Total | $800,000 |
$1,208,040 |
$480,450 |
If you now computed the present value of each year's income differential you would be able to compute the present value of the stream of additional earnings for a college graduate. The present value of the lifetime earnings differential of $1,208,040 is $480,450 which suggests that it is one great investment. You spend $100,000 to get $480,450 - an average rate of return equal to 20 percent.
Before you rest easily, confident that the investment will pay off, you should note these are averages. There are some students that are flipping burgers and waiting tables five years out of school and others making BIG bucks. The fact is there are some choices you can make that will increase the odds the investment will pay off and you may want to check out some investment advice.