Week 3: Personal Finance

Week 3: Personal Finance

“Returns: What benefits do I gain from the education or training?”
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Summaries

  • Week 3 > Module 3 - Part 2, Returns: What benefits do I gain from the education or training? > Returns to Human Capital Investments
  • Week 3 > Module 3 - Part 2, Returns: What benefits do I gain from the education or training? > Returns to Postsecondary Education - Working Without Interruption
  • Week 3 > Module 3 - Part 2, Returns: What benefits do I gain from the education or training? > Returns to Postsecondary Education - Working with Interruptions

Week 3 > Module 3 – Part 2, Returns: What benefits do I gain from the education or training? > Returns to Human Capital Investments

  • If you major in the humanities, your returns are likely to be between 5% and 10%. By way of contrast, if you major in business or engineering, your returns are likely to be 13% to 16%. Turning to the social sciences, if you major in economics, as I did, your returns are likely to be 12% to 14%. By way of contrast, if you major in psychology, which may be far more interesting than economics, your financial returns are likely to be lower, say 5% to 10%. Recent research shows that high returns to investments in education and training depends critically on technical skills.
  • Here is a list of returns by institution, and you’ll note that the institutions with the highest levels of return tend to be technical schools.
  • The economists looked at these data, and produced a graphic that actually shows you much more clearly how having technical skills can affect the return that you receive on your post-secondary education.
  • Here, the blue dots are the technical fields- engineering, computer science, and math- business and economics are the orange dots, and the sciences are the yellow dots, the humanities are the blue dots, and the arts are green dots.
  • You can see that in general, the technical fields- those fields such as engineering, computer science, and math- have the higher returns to education and training.
  • You can see that the lower returns tend to come for the areas of the sciences, humanities, and arts.
  • The sciences, a little lower and much more spread out, and the spreading is your level of risk.
  • You see the much higher rates of return and much less dispersion of returns.
  • Looking then at the humanities, you can see that the humanities also are risky and tend to have much lower return.
  • The important message here is that if monetary returns are important to you, then getting technical skills- that is, taking subjects related to engineering, computer science, and math- are the way to go.

Week 3 > Module 3 – Part 2, Returns: What benefits do I gain from the education or training? > Returns to Postsecondary Education – Working Without Interruption

  • The first assumption is what she would be earning if she were a high school graduate- and that is $22,500 per year- and what she would be really if she were a college graduate- $45,000 per year.
  • In order to project those earnings over the entire career that Natalia will have, we need to know how the earnings of the high school graduate in the college will grow over time.
  • You can see that consistently, the earnings of a college graduate grow far more rapidly than the earnings of a high school graduate.
  • When the two are 18 to 24 years old, the high school graduate’s earnings will grow by 4%, and the college graduate’s earnings by 6%. At the end of their career, the high school graduate’s earnings will be growing by 1%, and the college graduates by 2%. This difference in earnings growth exacerbates the differences in original earnings, and means that they will have far different lifestyles.
  • To make this original spreadsheet somewhat simple, we’re going to assume that both the high school graduate and the college graduate will be employed 100% of their career.
  • With this assumption, the high school graduate will work for 47 years and the college graduate for 43 years.
  • Between 18 and 21, you will see that the high school graduate is working and earning money, and her salary is growing by the 4% per year that we talked about.
  • Looking down, you can see that because of the differences, the higher growth rates for college graduate, rather than the high school graduate, the difference between the earnings of the high school graduate and the college graduate grow over time.
  • By the end of her career, the difference is over $100,000, with the high school graduate earning almost $52,000 at age 65, and the college graduate $152,000.
  • It has the advantage of a higher starting salary- $45,000, rather than $22,500- and higher growth rates, which are compounded and grow over time.
  • By way of contrast, if a college graduate’s salary is increasing by 5% a year, that college graduate’s salary will double in only 14 years.

Week 3 > Module 3 – Part 2, Returns: What benefits do I gain from the education or training? > Returns to Postsecondary Education – Working with Interruptions

  • To summarize Natalia’s earnings and to show the power of compounding, let’s look at the percentage increase in earnings for Natalia, the high school graduate, and Natalia, the college graduate.
  • After five years of working, the earnings of the high school graduate have increased by 15%, the earnings of the college graduates by 24%- the difference between compounding 4% annual growth and 6% annual growth.
  • The high school graduate’s salary will have increased 29% and the college graduate’s by 55%. The difference in salary increases are growing over time.
  • By the age of 65, the high school graduate’s salary will have increased by 134% and the college graduate’s salary by 238%. That is, the high school graduate’s earnings will have more than doubled over the course of her career, while the college graduate’s earnings will have more than tripled.
  • For Natalia, and for most of us, this just is not the case.
  • Natalia the high school graduate is unemployed more than Natalia the college graduate.
  • Finally, Natalia the high school graduate is out of the labor force more than Natalia the college graduate.
  • Remember that those returns are the difference between her earnings as a college graduate and her earnings as a high school graduate.
  • Natalia the high school graduate has her first child at 25 and stays home.
  • While she’s staying home, her earnings are $0. Natalia the college graduate continues to work and has substantial returns to her college education.
  • Natalia the high school graduate continues to stay home until the age of 30, and, at that point, she begins a search for a job and spends a year searching for a job.
  • You can see that Natalia the high school graduate is earning substantially less at the age of 37 than Natalia the college graduate.
  • Continuing down the career trajectory of the high school and college graduate, we see that Natalia the high school graduate becomes ill at the age of 50 and stays home because of illness for two years.
  • Natalia the college graduate continues to work and continues to have substantial monetary returns to her college education.
  • Natalia the high school graduate transitions back into the labor market at the age of 52 and has one year of unemployment.
  • Natalia the college graduate continues to work for two more years, and, at that point, leaves the labor market to take care of her aunt.
  • Now, what are the implications of this very different, and more realistic, employment history to the returns on Natalia’s college education? The total value of the returns- that is, the net present value- declines to about $400,000, and the estimated rate of return declines to 13%. These are still very large numbers.
  • Natalia’s education and training is clearly worthwhile from an economic perspective.

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