It’s That Time Of Year Again*
What time? College decision time.
If you have one or more kids that are approaching the time when they fly the nest, you’re either involved in this in some way or likely will be.
I’ve hammered on this nail many times, but I’m going to do it again today, because right about now is when decisions have to be made about next year and bad decisions here can cripple or even economically destroy a young adult.
This is not overstating the case folks.
In the 1970s and early 80s you could spin pizzas or wash cars and put yourself through school, and many people did. Today that is nearly impossible, and a big part of the reason is that schools have gotten predatory and treat young adults not as a mission but as a revenue source to be extracted from to the maximum possible extent.
I look at balance sheets literally all day long. Guess what: So do colleges, and the balance sheets they’re looking at are yours, having essentially forced your disclosure through the FAFSA.
Simply put colleges know on-aggregate what their degree is “worth” in discounted cash flow over a period of time, say, 10 years (the typical student loan repayment period.) Over the last two decades they have increasingly ratcheted up their price to approach as nearly as possible that delta in value and in many cases exceed it, with full knowledge that they’re doing so.
What this means to you is that the marginal value of such an education, that is the delta in earnings power less the price of obtaining it, has trended toward zero and for many fields is deeply negative.
There is another side to education that is non-monetary, and schools know that too. That’s the value of “prestige”; the social value that allegedly comes with a degree from a given school. Here’s the problem: Most of that so-called “social value” is not really about the school, it’s about who you are and you either have it or don’t before you go. Where this really gets bad, incidentally, is in the private college area where that “cachet” is played to a ridiculous degree.
Before you fall for the glossy brochures and wonderful tours I want to put some numbers on this.
The 2011 graduation rate for full-time, first-time undergraduate students who began their pursuit of a bachelor’s degree at a 4-year degree-granting institution in fall 2005 was 59 percent. That is, 59 percent of full-time, first-time students who began seeking a bachelor’s degree at a 4-year institution in fall 2005 completed the degree at that institution within 6 years. Graduation rates are calculated to meet requirements of the 1990 Student Right to Know Act, which directed postsecondary institutions to report the percentage of students that complete their program within 150 percent of the normal time for completion (that is, within 6 years for students pursuing a bachelor’s degree). Students who transfer and complete a degree at another institution are not included as completers in these rates.
Is it sinking in yet?
That is, four out of ten do not manage to complete their studies in six years.
Now folks, step back a second, because the price you’re quoted is predicated on four years of work. Inflate it by another 50% if there are two more years required!
That little scam, incidentally, is not new. Colleges are notorious for setting scheduling up such that it’s nearly impossible to get a gatekeeping class (one that’s required to progress in your major) at the point in time where it would usually fall. This forces the student to take an extra semester worth of work (at an additional cost of another semester’s tuition, room and board!) and the problem only becomes more-acute if there is any interruption in progress (such as a class you fail or have to withdraw from for any reason.)
By the way, if you think the tony private and very exclusive institutions are particularly better in this regard you’re wrong. Private, non-profit colleges (those nice expensive highly-credentialed ones) still have a one third failure rate after six years, or just marginally better than the 59% completion rate overall.
Guess what the numbers are for 4-year completion? Less than four in ten.
At a four-year public institution? 32% or about one third. Non-profit? 52%, better, but still nearly half do not finish “on-plan” and therefore on cost. For-profit? 36%, or about one third.
This, folks, is very, very important because all of your pricing data is predicated on you finishing within four years. You’re off by half if it takes you six and if you don’t complete at all it’s a sunk cost!
Now I’m sure you’re going to tell me that your little snowflake is special. Very special. And he or she will never flunk out, will not fail, will succeed, get through in four years and then go on to get a great job that will make this all work out.
Just remember that the more-exclusive the school the more likely it is that every single person there believes they are also one of those very special precious snowflakes, and not ordinary. Yet the fact remains that of those “special snowflakes” at these exclusive private institutions half of them melt into slush and are financially damaged against expectations, and one third fail to complete their degree at 150% of quoted cost and are decimated.
And oh by the way, this is just the bad news as regards the odds of graduation. Statistics also tell us that half of college graduates are working at a job that does not require their degree. Fully one-third of graduates are working jobs that require no more than a high school diploma. In other words their expensive degree is not only worth zero it has negative value because they decided to forego four to six years of earnings in that job to acquire it!
Remember that there is no discharge in bankruptcy for student loan debt. Period.
The damage is not just to the kids either; schools press hard to get parents to blow all their money as well, including reaching into intended retirement funds. That’s an outrage, especially when the odds are taken into account of not finishing at all, but it happens every single day.
Further, as a parent if you co-sign they will come after you and sue you to beyond the orbit of Mars to force payment, even if it means losing your house — and everything else you own. To emphasize the point: Student loan debt is not dischargable in bankruptcy — period.
Now let me add one final piece of frosting on the cake for you, which is also not clearly disclosed up front. If you default on a student loan there are statutory penalties, retroactive interest and fees that get added to the balance since these are all federally-guaranteed, and those penalties and fees frequently run to 50% of the balance. That’s right; if you default on $50,000 of student loan debt you now instantly and irrevocably owe $75,000 instead of $50,000, and you can’t discharge any of it in bankruptcy.
The post-secondary educational game is a form of financial rape that we have encouraged through the years first by allowing student loan debt to treated “specially” instead of like any other unsecured debt and then by making it available to pretty much anyone who asks. The result is that colleges have run the numbers and added their glitzy marketing to the package, putting forward a premise that for four out of ten incoming students fails to advance their economic prospects and damages them instead.
In most lines of work a business that did this sort of critical damage to people on a routine basis with four out of ten being economically destroyed would be considered a criminal enterprise and the perpetrators — all of them — would be prosecuted.
But in this case it’s considered something to look up to instead, as the perpetrators are found both in the colleges and the government itself.
Folks, I’m a parent. I, like everyone else who is a parent, believes that my child is special. But as a parent my first and foremost obligation is to provide guidance based on my longer tenure of experience to my younger, starry-eyed offspring, and not to get the stars in my eyes as well. An 18 year old is no longer a child, and if my child decides to put herself into debt to attempt to gain an education that she is odds off to complete within the plan and cost that is sold to her, and has a four in ten chance of not completing it at all, that’s her call. The day she turns 18 I cannot stop her from doing so.
But if I enable that act in any way, shape or form, or worse, actively encourage it, knowing these odds, then I deserve to be BBQd and eaten if her gambit fails, because nobody in their right mind would willingly take a gambit that has a 4-in-10 chance of economically destroying their future given the existence of other options — and there are other options.
There are ways to attempt to gain a post-secondary education without debt. A potential sunk cost that is not debt-financed is simply an expenditure that didn’t work out. That is supportable. It’s difficult and for some people it means not going to college at all — but that is in fact the right choice for a significant percentage of young adults.
Debt-funded post-secondary education, on the numbers, especially when the quoted figures are intentionally understated by as much as 50% for the typical case, is simply not a supportable decision.
Period.
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So About That College Degree….*
Yesterday I generated quite a bit of discussion regarding academia and how it has turned education into a balance-sheet exercise — aimed at you, the consumer of education.
That is, how they have analyzed your balance sheet (as a parent) and the potential balance sheet of your just-turned-adult former child, figured out how much they believe their “education” might be worth, and then charged your “kid” the non-discounted maximum amount (without accounting for the risk of failure!) that they can get away with and not drive the ROI (obviously, at first blush) negative.
The problem with this approach is that it leads the ROI to frequently be negative. It is negative with certainty for anyone who fails to complete their studies, as just one example. But it is also negative with certainty for anyone who completes their studies but fails to find a job that uses their degree.
In those two cases the negative return is drastically higher than it first appears, because in order to get the (worthless) degree you also must give up time — the only resource you cannot buy more of — and in the process you forego earning money at a full-time job. Not only does this handicap you in terms of real-world work experience it has a direct negative impact on lifetime savings and investment.
But in this article I’d like to focus on those who succeed – that is, those who are in the 4 of 10 (or 6 of 10) who complete their studies within four or six years. That is, those who follow the path and manage, despite the odds being either against them or only slightly with them, to get that sheepskin.
There are two possible means by which one arrives with the tasseled cap on their head: With student-loan debt and without.
Now here’s the ugly: As a person who has hired — who has sat in the left seat, or the corner office if you prefer, and had the title “CEO” for quite some time — I will say this very slowly and clearly so there is no mistaking my position.
Yes, I will run a credit report on every applicant (and disclose that I’m doing so up front.)
Yes, I will refuse to hire you if you have a material amount of student loan debt. And by the way, just so there’s no misunderstanding, I’ll define “material amount” for you: More than ten percent of your expected first-year annual salary.
Yes, that is legal.
If you manage to make running credit illegal then I will simply look at the cost of education where said degree came from and immediately throw in the trash all resumes where it is impossible to earn said funds as a student contemporary with the degree, or where said resume fails to disclose the earning of said funds during the earning of said degree.
No, I will not change my mind.
What I will do is explain why I have this position.
A person with a newly-minted degree is entering a highly-competitive environment known as “work.” In this environment they are charged with one, and only one thing: Being worth more to the company, net-net, than they cost in compensation and associated expenses.
That’s the beginning and end of it, when you get down to how business, hiring and “human resources” work out. No business can stay operational if it operates at a net deficit in this regard and as an applicant, no matter your credentials, you are not special or an exception to this rule.
The problem is that when you come to me with a material amount of debt your job satisfaction for a given amount of compensation is burdened by the fact that you must write that big check every month to the lender who financed it. This means that I am going to get fewer smiles on-balance from you than the candidate who has no debt. Since your acquisition of same was voluntary you are not a protected class having taken this choice and therefore it is not “discrimination” if I prefer to hire someone who has not voluntarily done the same thing as it is more likely their job satisfaction, and thus performance on net, will be greater than yours is.
It is thus just good business sense for me to prefer candidates without said debt.
If that renders those “tony school” programs unmarketable, tough crap. Go take it up with the Provost at the university who sold you unmarketable paper and in doing so ripped you off for a hundred large or more.
Your beef is with him or her, not with me.
Oh by the way, for those in the “educational industry” that claim I’m being unfair in my previous article because students who come in with a bunch of AP or dual-enrollment credit (or transfers) are not tracked in the statistics and thus don’t count, let me fire back at you: A student who transfers in with two years of credit earned now has to complete and graduate in two years, not four, irrespective of how they got the two years of earned credit. This little ditty you like to use as an excuse cuts both ways and colleges don’t publish those statistics (because they’re not required to.)
I will go on to observe that nobody ever hides good news; if in fact those students coming in with a ton of AP or dual-enrollment credits maintained their pace as expected universities would be trumpeting this data in an audited and provable fashion. They’re not and that tells me everything I need to know..
So here’s the deal: Go to school if your degree will give you an edge and you’re reasonably sure you will complete your course of study.
But:
Don’t go into material amounts of debt to do it. If you find yourself on the other side of the podium with a turned tassel and $5,000 worth of debt (all-in) doing so, that’s fine. If it’s $50,000 you’re screwed if your resume comes across my desk as it will feed my paper shredder’s appetite without further consideration. Further, I have, am and will continue to advocate that other CEOs and hiring managers take exactly this approach to anyone who comes to them with material amounts of student debt.
Be honest with yourself about your odds of success and the cost of acquisition of the degree. This is not easy to do but the fact of the matter is that as an adult you better start acting like one, including honest self-assessment in the face of glib-talking finance officers, Deans and Provosts. The fact is that schools all sell the “4 year” program when it comes to costs but you are not odds-on to complete in four or less years. There are those who claim this is not “intentional” on the parts of colleges but I will stand up right now and call them liars to their face, as I have seen more than enough examples over 30 years time to form that opinion and until their behavior changes my opinion will not. Yes, it can be done in four or less years, but the process is designed so that it only happens on that schedule with (a) near-perfect diligence on the part of the student, (b) often more than a bit of good fortune and/or bootlicking by said student and (c) no true accidents or other disruptions. The problem is that life doesn’t work this way and that fact is reflected in the statistical reports that show the percentage of students that complete within four years. Reality is that this bucket of students comprises less than half of those who matriculate virtually everywhere.
You may think that I’m being unreasonably harsh or perhaps you think I’m full of crap and that my opinion doesn’t matter. But before you dismiss this viewpoint out of hand and go on your merry way as a student — or parent of a would-be student — you ought to at least sit down over a cup of coffee and consider that perhaps my viewpoint either is now, or could, become that of at least a significant minority of the hiring managers in the industry you are choosing to enter.
At the end of the day the question becomes this as a young person about to enter college: Why would you choose to knowingly and intentionally handicap yourself when it comes to your future in the workforce?
That’s exactly what you’re doing if you take out student loans.
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College: Probability, Investment Odds And Outcomes*
As the third in my series I want to now present the coup-de-grace aimed straight at the jugular of the post-secondary educational “industry.”
You’ve read my missive on the basics of collegiate financial aid and how, on-balance, it’s a bad deal.
You’ve also read my perspective as a former CEO who thus made lots of hiring decisions, and exactly how I would make those decisions in the future were a candidate to come to me with significant student-loan debt — and why.
Now I’m going to give you the personal tools to determine whether what you are individually sold by High School counselors, College admissions officers and those in the finance office are being honestly presented or whether you’re being scammed.
I am going to ground the entirety of this discussion in well-understood and validated principles of risk management as it relates to investment return. Since education is an investment it should be valued exactly as any other investment would be.
I’m going to pick on one specific educational institution: North Carolina State University, a 4-year public institution, which is fairly typical.
The total annual (in-state) cost is listed as $22,075, for a four-year cost after grants and scholarships of $52,100 (assuming a median family income — in the $48-75k bracket.) Note carefully that if your family income is over $110,000 you are expected to receive zero in grants and other aid, that this boosts the price over four years to $88,200, and that $110,000 is not a lot of income if you live in a city of significant size! In short, I’m being charitable here and using the median income.
Now let’s further assume that this $52,100 of cost is taken out in loans. Federal Student Loans are currently fixed in rate at 3.86% and accrual is deferred until you graduate. They are also limited in term to 10 years.
On your graduation you will have a monthly payment of $522.35 due for the next ten years.
The common chestnut promoted by colleges is that this must be 10% or less of your income to be affordable. Well, $522.35 monthly is $6,268.20 a year, so if you want to believe the college financial folks you must have a reasonable job prospect at the time you graduate four years in that pays at least $62,682.00 a year in salary.
Colleges have tables for this sort of thing, and so do various private sources. One is found at “simplyhired” and it shows that a sales professional, IT specialist, program analyst, mortgage protection professional, sales rep, general engineer or IT specialist is likely to meet this requirement.
There is a problem however — the average first-year job in their database only pays $53,000, which is almost $10,000 short of the requirement. Therefore, if you’re “average”, you’re in trouble.
I’m sure at this point there will be plenty of people who will simply say “but if I choose the right field I’m good” right about now, and the smiling college admissions and finance officers will do so as well.
Unfortunately you’re wrong and they’re lying, either by omission or commission — and they know it.
See, this is an investment, remember? And for a binary (graduate or not) investment we must compute the discounted value (or cost) of the expected return (or expenditure) using the probability of success.
In other words you can only say that an investment is “successful” if it can lead to a positive outcome; if it leads to a negative one than it has failed. Since we’re financing the investment failure is easy to define — if we are unable to earn enough to afford the payments, or get nothing from them because we don’t finish our degree, that’s failure.
This computation, by the way, is very charitable to the college and claims that your investment is a good one — there are other considerations that must also pass for the investment in education to be truthfully considered successful, including the discounted cash flow you can earn on the money elsewhere that you spend on the education plus the foregone earnings power over the time you’re in school less the improvement in earnings power from the degree over your career. In other words the return on the spend funds plus the foregone income during those years must be less than the increase in earnings from the degree itself, both on a discounted basis over time. Those figures, however, are subject to a lot of dispute, are highly-variable and impossible to know with certainty for decades — which means people can claim you’ll do fine without any evidence to back it up and you can’t refute their argument with facts, since you won’t have them for 20 or more years and worse you’ll never be able to prove the counterfactual (the outcome had you made the other decision.)
The risk-adjusted investment outcome test, however, is one that has a time horizon that doesn’t extend beyond your graduation and as such we can pass or fail it right now off the school’s own statistical data.
So we’ll just start with that first-level analysis. 41% of the matriculating freshmen graduate “on plan”, that is, within 4 years or less. We therefore must divide the $62,682 by 40% in order to get the investment odds-adjusted salary that must be available in the first year to a graduate for a freshman entering the college to consider the risk he or she is taking on to be worthwhile.
What is that figure? $156,705 in first-year salary must be expected given a 40% completion rate in order for the investment odds to make sense.
Good luck, because there is literally nothing in the tables at SimplyHired that gets there.
In short you’re screwed on the investment odds of going to this school if you have to finance your education irrespective of your field of study.
But that’s only the first part of the calculation and it factually gets much worse from there. Let’s keep going, and look at the six year rate plus all the other related probabilities.
72.5% of the students at NCSU graduate in six years or less. Six years is more than four, and now you have $78,150 in student debt since you had to finance the other two years of school. This makes your payment $783.52, which is $9,402.25 a year. 10x that is $94,023 in salary, which again is off the charts at SimplyHired (the best is a sales rep at $88,000.) And that’s bad, because even not adjusted for the investment odds you’re not going to be able to afford those loans if it takes you six years to finish instead of four!
Unfortunately as you now know you must also adjust that $94,023 for investment odds and when you do the salary requirement is in fact $129,687 in first-year salary.
The paradox in these figures is that you actually are ahead on investment odds if your education takes you six years instead of four, but unfortunately the six-year plan even without adjustment for completion odds does not, on-balance, succeed.
There is no winning strategy for the six-year program — not only can you not get a job that pays $94,000 right out of school the odds of you finding a first-year job with a Bachelor’s Degree that pays $130,000 (the risk-adjusted wage) are approximately equal to that of being hit by an asteroid tomorrow morning at 8:03 AM, as they’re not materially better than finding one that pays just over $150,000.
This means that any attempt to claim that you should stay in school for the additional two years is a lie because you have already lost once you exceed the 4 year window on an unadjusted basis.
That also means, incidentally, that on the basis of investment odds it’s a losing investment if you have to finance it, looking at the numbers from the perspective of someone about to matriculate.
Any person involved in finance, or for that matter anyone who plays poker for money, knows how to calculate this. It is inherently part of computing the statistical favor (or lack thereof) that lies in any investment. Poker players do this in their head on virtually every hand (if they’re any good at all) and they fold their cards rather than throw good money after bad when the investment odds no longer work in their favor.
It would be nice if that was the end of the calculation of money odds, as I’m sure you have a sore ass by now having sat through this. Sadly, it’s worse than that — by enough to make you bleed profusely.
See, only 62% of college graduates have a job that requires a degree at all, and only 27% of them have a job that requires their degree — in other words, that they studied for.
Now I’ll be nice, because the numbers get so damning so fast if I actually use the real figures that your eyes will pop out of your head. So instead I won’t do that (the 27% figure); I’ll use the 62.1% figure instead. Why do I have to adjust for this? Because it is a near-certainty that if you have a no-degree job (e.g. pulling coffees at Starbucks) you will not be able to afford the loans.
We therefore adjust the money odds requirement for salary of that six-year degree (remember, I said I’d be nice!) by the 62.1% odds that you will get a job that requires a degree. Now your first-year salary must be $208,835.58 for your education at this institution to be worth it as an investment when viewed from the standpoint of a matriculating freshman.
There is no job that you can obtain with a Bachelor’s that will hit that number. You may as well play Powerball instead.
I only wish the bad news ended there, but it does not.
Since this is a financed investment we must also compute the probability that you will go the entire 10 years without an income interruption that causes you to default on the loan. The reason for this is that success in a binary investment is not just determined by the odds of the desired outcome occurring once the investment is made, but by the ability to pay for that investment, in this case fulfillment of the loan contract. What are the odds that you will go for the first ten years of your professional life and not be involuntarily separated from your job and be unable to make the payments?
I don’t have that answer. But let’s assume that there’s a 80% chance you will succeed in this endeavor of making 120 on-time payments of $783.52 and not default. I personally think that’s too high, and the statistics on defaulted student loans seem to bear it out, but it’s too early to know right now. So while I think I’m being charitable, I may be off either direction on this.
But that brings the minimum first-year salary requirement to….
$261,044
Is it realistic that you will make that much with a Bachelor’s in your first year out of school? No, and it doesn’t matter what field you’re studying in. Indeed, it’s rather unlikely that with a Bachelor’s you will ever make that much money in a year outside of running your own business, and if you are running your own business you almost-certainly don’t need a degree at all.
By the way, if you default that preferred interest rate up above disappears instantly and there are stautory penalties and fees that get added onto the principle that will typically double it. That is, if you default you will almost-certainly be rendered instantly bankrupt and you cannot discharge the debt in that bankruptcy either, which means it will follow you until you pay off not the original amount but double that amount at the much higher interest rate, rendering the total amount you pay over time three to four times what the original debt was.
It is very, very easy to wind up paying $250,000 in total on a $60,000 student loan if you default at any time during those ten years — especially if you do so early on.
Now let me give you the worst news of all. That $783.52 is within a couple of 12 packs of beer a month of the P&I requirement for a $150,000 house on a 30 year mortgage @ 5% interest, which is very achievable right now. In fact that payment is $801.89, a payment that according to your local mortgage banker can be afforded if you make a mere $30,000 a year. Now granted, $150,000 of house is not much (if anything!) in many parts of the country — but do recall that we’re talking about a young person starting out, and perhaps starting a family. It’s entirely reasonable to think you might be shopping in this price range under those circumstances.
The problem is that once you have the $783.52 payment it has effectively replaced your ability to buy a house, and if you are involved with or married to someone with an equivalent student loan debt then it’s double that.
That means you won’t be buying a house for at least ten years, until the debt is completely paid off, and that assumes neither of you defaults. If either of you do default you will never buy a house because you will never qualify since you will not be able to pay it off nor can you discharge the debt in a bankruptcy.
What does this mean?
It means that if you come out of college with a bunch of student debt you are unmarketable as a life partner for anyone who has the first bit of common sense – all of your choices for partners will be people who are too irresponsible or too stupid to figure any of this out.
For cash-paid educations (where you work your way through school, for example) the computation is different, because intangible value comes into play. There it can easily be argued that education, even at today’s bloated prices, may be worth it — depending on your field of study. In those instances you should be looking at the discounted value of the funds you will spend plus the discounted foregone earnings over the time you’re in school (but could be working) less the improvement in your earnings with all three carried forward to retirement. Remember that you must discount the expected improvement in earnings by the probability of completion, exactly as you do up above.
But any time you finance the acquisition of your education the outcome is binary before you run that computation on earnings improvement – you either earn enough to pay off the loan or you don’t. Since the outcome is binary the calculation of investment odds is straightforward and is determined by the cost of the investment divided by the odds of success, end-to-end and only then can you look at the improvement in your earnings power.
All of the so-called finance professionals know that this is a fundamental computation for all financed investments yet not one college will ever place this in front of you as a clear disclosure when you are in their admissions and finance offices.
The entire student loan “industry” relies on them not presenting to you this fundamental fact as if you did you’d force them to justify their costs on aninvestment risk-adjusted basis. The reason is simple: on an investment risk-adjusted basis the average college education is overpriced by a factor of approximately 400%. It is thus absolutely critical that you run this analysis personally for your particular situation and that you demand sufficient audited data to do so with full recourse against anyone who gives you false information in this regard before you commit to an educational loan.
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Yet Another Reason NOT To Go Into Student Debt*
So by now you have three reasons to tell the college finance office to go blow a donkey when they “propose” that you go into debt to fund your education. You can read them here, here and here again if you need to.
Now I’m going to give you the biggest reason of all not to do it, and it has to do with your personal wealth over time.
It’s simply this: Statistically speaking you will never get rich working for someone else.
Oh sure, there are exceptions. You might wind up working for the next Google before it goes public, and be far enough up the food chain that you get stock options and the company hits the home run in the public markets and those options vest and they’re successful long enough for you to cash them out.
That’s a lot of “ands”, by the way, so let’s put probabilities on it.
Working for the next Google: 1 in 10, if you work for a startup. 9 of 10 fail entirely.
Being far enough up the food chain to get a lot of options: 1 in 5, if you’re high-skilled.
The company hits the home run: 1 in 10 again; from venture capital to IPO with nothing that blocks them in the middle somewhere due to a mistake.
The options vest: 75%, probably, provided you get the other three first.
The firm succeeds long enough to cash them out: Lockup periods and all, you know. Maybe 50%.
So how’s this work out? .1 * .2 * .1 * .75 * .5 = 0.08% chance.
In other words, less than 1 in 1,000.
Still think this is a good path to getting rich? Uh, no.
By the way, I still have some paperwork somewhere around here with a bunch of options that I was granted in a spin-off that ultimately did go public. So I got 1-3, and guess what — the firm failed anyway and thus the options were worth zero.
Oh well.
This, by the way, is why you never, ever count those options as part of your compensation when you’re figuring out whether to take an offer in a non-public firm, even if it’s planning to go public. The odds are overwhelming that you have a nice small stack of pieces of paper with their highest and best value will be found in starting a campfire or your BBQ in a few years.
Now sure, there are exceptions. Google has its share of millionaires, as does Facebook. But remember that people win the Powerball all the time as well — this does not make buying Powerball tickets a good investment. In fact the lottery, just like options in non-public companies, are a stupidity tax to the extent that you actually expect either to be worth anything.
What options in non-public companies are is an incentive for you to work hard in an effort to make them valuable. They do a very nice job of that, by the way, and my comment on the odds has nothing to do with whether they’re proper to grant to people. They clearly are, and they clearly serve a purpose, but the purpose isn’t making you, the grantee, rich. It’s to do the firm’s level best to spike your performance in your job to the maximum possible extent.
So how do you get rich? You work for yourself.
Let me clue you in on a secret to working for yourself: It is utterly essential that your life overhead is as low as possible in order for you to succeed in working for yourself.
The reason is this: On average you will fail at least once, and probably more than once, before you succeed. It is only through having a very low life overhead in the form of essential spending that you will personally be able to get through those failures without being rendered destitute, having creditors chase you, being thrown into the street or all of the above.
Don’t be fooled either by the claim that you “have to” go to college to earn a good living. That’s a lie. You can do a number of things that don’t involve college yet make a darn nice living, and give yourself the opportunity for entrepreneurship. How about plumbing or electrical work? Both have no college requirement and reasonable apprenticeship or certificate requirements with you actually getting paid to learn the trade instead of the other way around. There are dozens of others, from various forms of physical labor to intellectual labor such as web design, and the nice thing about all of them is that none require going into debt of any sort in order to gain the “first job”, and most have a direct path into self-employment.
Now let’s look at the economics. Let’s assume instead of four years in college you instead spend them apprenticing for electrical work. Let’s further assume you can make $15/hour doing so as an apprentice, then $25/hour once you have the certificate or license. There are 2,000 working man-hours in a year, assuming 50 weeks of 40 hours and two weeks off for vacation.
So in the first two years you earn $30,000 each, and then $50,000 the next two. You do not blow all of this on creature comforts nor do you go into debt. Instead you stash 20% of your gross and live frugally. In those first four years you have amassed $32,000 in savings and have no debt.
The college graduate, on the other hand, has $52,100 in debt and at the nice low current interest rates will be paying $522.35 a month on graduation. The problem is that at graduation if he gets a $50,000 a year job he has $4,166 a month in gross income less the $522.35 in loan repayment, or $3,644.32 before taxes.
You, earning $50,000 a year at the same point in time, have $4,166.67 a month in gross income and no debt obligation at all.
Now let’s assume two things: First, from that day forward you both live equally frugally and spend the same amount. Second, the $32,000 the trade-follower amassed continues to expand.
Let’s assume that inflation is 3%, or roughly historical averages (yes, that’s 50% higher than Fed target, but it’s reality over the last 50 years or so.) Let’s further assume you can earn 6%, or 3% after inflation, and that we will do so for 45 years before you retire.
That $32,000 the non-college-goer amassed turns into $440,467.55.
What’s worse is that if you both live under the same standard of frugality from that point forward for the next ten years the non-college goer gets to add $6,268.20 to that balance every year for the first ten while the college graduate has to pay off the debt.
Now let’s look at what happens. The college graduate has zero saved at that 10 year point. The non-graduate has $139,926.99, and both are living under the exact same standard. The entire difference is the loan repayment the college graduate has to make.
Can he make this up over time with better salary? Maybe. How much does he have to make up? More than you think.
Guess what happens in 35 more years? The non-graduate has $1,075,490, and all of that is due to (1) living frugally during the four years while the college grad is in school and (2) socking away only the loan repayment he is not making during the next ten years.
By doing just those two things the guy who doesn’t go to college has over a million dollars when he’s 65. Note that this is a quite-conservative set of assumptions — if you can manage to get an 8% return (hint: not without a lot of risk you can’t!) then that “nut” is over $2 million at age 65.
Note that neither of these guys stuck one penny in a 401k or 403b, or anything like it, from that 10 year point forward. The college graduate is literally over a million dollars behind in retirement income at the point his student loans are paid off and he’s also 14 years behind in contributing — a crippling deficit that will require that he both make a hell of a lot more money and save more of it to catch up.
Now here’s the other part of it. Neither of these two guys will get truly rich doing this. The college grad and non-grad will work for someone else and while both can find their way to retirement and be ok, neither is going to hit the jackpot and retire at 40 on this path.
And here’s where the real bad news for the college guy who has to take out loans comes from.
During those first ten years the college grad can’t start his own business because he needs that $500+ a month every month without interruption — if he doesn’t pay he’s screwed, permanently. There is no way for him to cut way back for the inevitable bad months while starting up a business where there is little or no income.
The non-graduate has the option at any point in time to split off from working for someone else, and after a decade or less he’s going to be in a utterly excellent position to do so, assuming that he or she does good work. And it is there, in entrepreneurship, that one finds the path to wealth.
Wealth, by the way, is not really about having a lot of money when you get to 65. Wealth is actually about freedom. The choice to change careers, to raise your kids and be there for their important times, to take a day or a week off when you want to, to “retire” at 40 and go do something else. To have a kid that needs you there for him or her in some form or fashion so you back off on what you’re doing and voluntarily accept far less economically for a while, because you can and in doing so you’ll be ok. You can never do these things working for someone else; that set of options simply doesn’t exist.
If you’re a young adult there is one thing I will tell you above all else that will impact your economic success in life: Do not go into debt no matter how it’s sold to you or what someone claims you can accomplish with it.
Either find another way or do a different thing.
How do I know this is utterly true and works?
Because I’ve been there and done that, both personally and in business.
That is, in fact, why I can write this column, and why you’re reading it today.
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