Why ROI Is a Bad Metric for Evaluating Colleges
There is a growing trend suggesting that prospective college students compare the “return on investment” (ROI) of the schools they are considering. Unfortunately, this is an inappropriate measure of a college’s worth.
The concept of considering the relative value of the education you receive is fine. All is well and good with that notion. But ROI itself is a specific tool. And that tool is not appropriate for this task.
How to Measure ROI
ROI is calculated as the ratio of your return to your investment. When considering a long-term investment such as education, you can either calculate the return as an annual number or as a total one. Naturally, for comparison purposes, you would need to be consistent.
Let’s consider a simple example. First, suppose you were considering a school that would cost you a total of $50,000 to attend, and that you would expect to earn $40,000 per year for a 30-year career after graduating. The ROI can be considered to be 0.8, or 80 percent per year (40,000 ÷ 50,000). Or, looking in total, it comes out to 24 — that’s (40,000 x 30) ÷ 50,000. You could either say that investing in this education opportunity returns you 80 percent annually, or 24 times over your lifetime. Either one is correct.
ROI can do its job if the two schools you are considering are identical in cost.
For example, say you need to compare the school in the above example to one that also costs you a total of $50,000 to attend. However, with this school, you can expect to earn $45,000 per year for each year over the course of a 30-year career. In this case, you can calculate the ROI of this second institution and find that it compares favorably to the first because it’s larger. Of course, you don’t need a metric in this case — you can simply look and see that $45,000 per year is more than $40,000 per year and know that you are better off financially.
But ROI no longer works when the cost of education is not the same at the schools you’re considering.
Where ROI Fails
When the cost of attending the schools is not identical, the ROI is of little value. Consider the following example:
School 1 will cost $50,000 per year to attend for four years. You expect a 40-year career in which you earn $60,000 per year. Your ROI is 30 percent per year. Considering the metric in total, you can expect to receive 12 times your investment back from your education.
School 2 will cost you $90,000 per year to attend for four years. You expect a 40-year career earning $100,000 per year. Your ROI is 28 percent per year. Considering it in total, you can expect to receive 11.1 times your investment back from your education.
These numbers tell us that School 1 is the better choice — it returns more income per dollar invested. But their returns on investment neglect to tell you that by spending an additional $160,000 to attend School 2, you will earn an additional $1.6 million across your career. That is a lot of money. The larger ROI is not necessarily the better choice.
Why ROI Doesn’t Work for Education
ROI is a wonderful business metric. It’s an extremely useful tool. You can quickly see which of two competing opportunities will provide you with a greater return. But that is done in context. If you are considering investing $1 million in one of two projects, you can look at the ROI of the two projects, select the larger, and be okay. You do need to consider some other factors, but let’s say that things are otherwise pretty equal. Then the larger ROI is better.
Or a business may be looking at 20 projects of various sizes. It can use ROI to select projects until it has exhausted its pool of funds. Essentially looking at the combined ROI of a set of projects when you have a fixed amount of money.
But education isn’t like that. You can’t choose School 1 from the example and then go invest your additional $160,000 of education funds into a second parallel education project with a greater ROI than that of School 2. When you look at education, you get one project at a time. And comparing the ROI of two projects of different sizes does not provide you with information that is sufficient to determine which project is the better opportunity.
But You Can Use ROI Differently
Let’s go back to the School 1 and School 2 example. School 1 had the greater ROI, so we deemed School 2 as being of lower value. This in spite of the fact that we would make way more money after going to School 2. So what we really need to see is what the additional cost of School 2 does for us.
Incrementally, School 2 cost a total of $160,000 more than School 1 across the four-year period. And School 2 provides an additional $40,000 per year in compensation for a 40-year period. The ROI of the additional outlay to attend School 2 is 0.25, or 25 percent. The additional cost returns 10 times across your career. Those are very respectable investment numbers.
You can look at the ROI of the incremental cost and determine if it seems like a good value. That is an appropriate use of the information. But just looking at the ROI of schools with different costs to attend is a meaningless exercise.
The Bottom Line
Conceptually, it is a good idea to consider the value that you will receive from an education. But this is also a dangerous direction to go in.
It is appropriate to consider whether or not your education will help you attain employment that will enable you to pay back student loans, cover living expenses, etc. It is also appropriate to consider that different career fields provide vastly different monetary returns across your career.
But there is more to it than money. If you’re an artist, you would probably make an unhappy engineer, no matter how much you earn. It is one thing to think of the money associated with two different things that you want to do. It is quite another to think of the smaller amount of money from what you want and a larger amount from what you loath. Education choices are about a lot more than money.
The intangibles may be the biggest factor of all. Students should try to go where they want to go. A student with a lot of school spirit and enthusiasm — who believes that she is advancing in the direction of her calling — will be unstoppable. I don’t think there’s a number for that.