Investment In Knowledge Pays The Best Interest*

| April 26, 2018
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You've seen a million articles about the value of education, but I want to give you a financial planner's perspective. You read articles about investing, but you also are trying to earn a raise at work or get a promotion. You know the value of compounding interest, but having a higher salary would also give you increased monthly cash flow. Maybe buying a multi-family home to rent out is on your mind, but with all of the time that you would need to learn how to make that profitable, are you better off becoming invaluable within your profession?

Let's say you are 30 years old, make $75,000 per year with $5,000 of free cash flow. The other $70k goes toward expenses, retirement savings, taxes, etc. You have been making 5-10% retirement plan deferrals and now have a checking account flush with cash, let's say $20k. You may have other considerations for that cash- extra protection via life insurance or disability insurance, a child's college savings plan, a bigger home, etc. But what would the break-even need to be to validate an investment in education versus an investment in an appreciating asset?

Let's break this down in both a quantitative and a qualitative way:

Should they invest $20,000 to increase earning potential to $80,000?

Should they invest $100,000 to increase earning potential to $125,000?

Should they invest $100,000 to increase earning potential to $100,000?

Quantitative Analysis

For this analysis, I will ignore inflation: if your salary is going up 3% each year due to inflation, it is likely your expenses are increasing 3% as well. We also need to account for taxes: I used this calculator with Massachusetts assumptions, single filing, and 2 federal allowances. Essentially, $5,000 increase in salary led to $3,113 increase in net cash (this assumes you do not increase retirement deferrals).

So let's start simple. If we assumed annual investment returns of 10% (S&P 500 over the last 50 years), what would be the break-even point on a $20,000 investment for a $5,000 increase in salary? In this analysis, you're looking at 13 years, with a $30,000 increased net worth over the course of 20 years.

Thus, we can safely say that a $20,000 investment to increase your income by $5,000 would be a wise investment over the long term. What might $20,000 get you? It could be your out of pocket cost if your employer covers part of a local master's program. It could be a series of licenses or certifications. It could be a sales seminar or coach for one year. It could be a public speaking course. Your specific industry will dictate that.

Evaluate Your Cost to Benefit Ratio

Now, what if you are thinking about leaving the work force entirely to take on a 3 year post-graduate degree (MBA, law school, other master's program, etc). Let's say this will cost you $100,000 out of pocket. You will use your $20,000 in cash to live off of, potentially working part time, while taking out a loan for $100,000 at 7% interest. You will walk out of this school earning $125,000 per year instead of $75,000. Living by your previous standards, you will now have a free cash flow of $35,824. For simplicity, I am going to assume that you do not refinance your loan once you gain employment, but that would obviously move up this timeline.

Here, you are looking at an 11 year break-even point, with almost a $500,000 difference in net worth after 20 years.

*BUT HERE IS THE BIG CAVEAT: What if this program only gets you a bump to a $100,000 salary, or $20,563 in free cash?

After 20 years, we are only 60% of the way there had we done nothing and invested our modest amount of cash. Thus, we can't make a broad statement that "education pays the best interest" without acknowledging the HUGE caveat that it could shoot us in the foot if we don't properly evaluate what it will do for us financially.

Qualitative Analysis

Is higher education strictly about how much more money you will make? Of course not. First of all, these spreadsheets assume you are employed the entire time without being fired. The more education you have, the greater your job security: while today's unemployment rate sits right at 4%, it is just 2.6% for those having college degrees or greater. During the recession, unemployment for those with college degrees peaked at 4.5%, while the rate for those with only a high school diploma jumped to 11%, and 15% for no high school degree.

There is also something to be said about the quality of your work life due to your ability to specialize. In my case for example, graduating with a "finance degree" is fairly broad and may not have allowed me to work exactly where I wanted, which is handling the personal financial lives of individuals. That was where the CFP® came in, with the all in cost coming to about $10,000. I have specialized even further in this realm to work with small business owners' retirement plans through the CRPS® designation. 

I would highly recommend this article about Edward Kandrot who at age 49 has already worked for Microsoft, Adobe, Google, Apple, and Facebook. He has obviously understood the value of learning to become invaluable to these organizations. This quote could be applied both as an employee serving their employer, as well as a business owner serving their customer's needs:

I try and pick something that I haven't done in the past and I can learn, but I also want to bring a skill set where I can solve the task and deliver it for more than what they are paying me. After all, a company at the end of the day is in the business to make money. I also want to find a company where I can contribute and feel like I am having a positive impact.

Conclusion

In the spirit of increasing long term net worth, I have not come to any new conclusions that you probably haven't already read. Generally speaking, more education will increase your earning potential, but you have to watch the cost. My main point here is to really evaluate what areas could give you the best bang for your buck. It does not have to be a master's degree, but could instead be an online course for $500 that could pay major dividends. Alternatively, it could be a master's degree despite the high cost because you know what your marketability will be after graduation. Finally, you may find that you should not pursue any further education if you have reached the apex of your career and earning potential- instead, stock or real estate investments may be a better deployment of your excess capital. An analysis like this is not difficult or time consuming, but could really change your perspective and level of wealth if you give it strong consideration.

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