When we think about college, words and phrases such as “income mobility” or “increase in wealth” come to mind. Ever since we were children, our parents and teachers have instilled in us that our ultimate goal should be to get into a good college to become successful. However, is that really true?
Let’s look at a career path in finance. This is a financial blog so we’re going to be biased toward this major but if you’re majoring/looking forward to majoring in other fields in STEM, look up the career path that you’re interested in and pay attention to the salaries. With that being said, our example is going to be investment banking. Take a look at the following table below:
|Position||Base Salary ($000s)|
For the purposes of making calculations easier, we’re only going to be looking at the first 5 years after college. Again, replace the position and salary numbers with whatever career path you’re interested in. In investment banking, typically one is an analyst for 2 years and spends 3-4 years as an associate before being promoted to vice president, which will not be covered because it’s outside the 5 year span.
Now let’s pull out our trusty BA II Plus financial calculator (also fine if you’re using a HP-12C you sick !@$#s) and run the numbers. Assuming that you go to a reputable in-state state university which typically charges $30,000 per year or $120,000 total, you would achieve an internal rate of return or IRR of 65% or a 5x multiple of invested capital or MOIC. That’s really good. However, this is assuming that you go to a in-state (IS) public school, take on no debt, and break into investment banking which is a very competitive field. Let’s say that you go out-of-state (OOS) or to a private college. Assuming that you take on no debt and total tuition cost for all 4 years is $200,000, your IRR would be 40% or a 3x MOIC. Additionally, for both cases we’re assuming that you make $70,000 for 2 years as an analyst with no raises or bonuses and $140,000 for 3 years as an associate with the same assumptions. Isn’t that great?
Wrong! Gotcha didn’t I? These salaries are pre-tax, meaning that Uncle Sam and wherever state you live in hasn’t taken their share yet. Below is an adjusted table for taxes, assuming a 40% effective tax rate.
|Position||After-Tax Salary ($000s)|
Now if we do the same calculations, below are the results.
|School Type (4 years)||IRR (%)||MOIC (x)|
For some reason, counselors and advisors only give us the pre-tax figure when they tell us about potential career paths to explore which I think is deceiving because taxes are mandatory. The after-tax numbers clearly show that the numbers aren’t as rosy as they appear which is clearly reflected when we calculate the IRR and MOIC. The numbers are a lot worse if we used a less lucrative career path. If you can only get one thing from this article, definitely go to the cheaper school after accounting for all the scholarships and the program quality.
Now let’s say that you didn’t go to college and instead you bought a business. Going on BizBuySell (obviously don’t use this as a one-stop shop if you’re actually looking to buy a business! Always do your own research), we’re going to filter for a manufacturing business that generates at least $100,000 of seller’s discretionary earnings (SDE, which is on an after-tax basis). Below is a listing for one of those businesses.
The listing claims that the business generates $560,000 a year in SDE and is listed for $70,000 (the listing states that the owner’s wife has passed away so most likely the owner needs the cash quickly and is trying to sell the business ASAP, hence the extremely low price). Obviously you should always perform due diligence and examine the financials that the broker will provide after you sign an NDA but assuming this is true, you’ve made over double your initial investment in a year if you paid the full listing price in cash.
Typically in a normal sale where the owner is not in a rush to sell, a small business typically sells for 2-4x SDE. Remember that this isn’t Wall Street so you’re not going to see the extreme multiples in tech or other high growth sectors. Additionally, downpayment is typically 10-20% of the final purchase price. Thus, instead of spending $120,000 for college you could have used that to purchase a business worth $1.2M that generates $300,000 in SDE annually. Assuming that after debt payments and other expenses that the business generates no SDE for 4 years and you sell the business for the same purchase price in year 5 with the SDE that year being used to pay for debt and expenses (so 0 again), you would generate an IRR of 58% or a MOIC 10x! This is assuming that you want to be an entrepreneur and that you don’t run the business into the ground but a leveraged business acquisition could potentially generate more returns than attending college.
College is not the end-all for financial success. While this article may seem to bash college, remember that for the majority of people who aren’t sure what to do, definitely go to college. However, if you are looking at alternate career paths consider trade school or business acquisition. For a lot of the manufacturing businesses, you could even become a welder and later purchase a welding shop. The possibilities are endless so don’t think college is the only goal.