How to calculate ROI on education (properly!)
- Cam Bestwick
- Apr 1, 2022
- 13 min read
The need to get better 'return on investment' from education is rapidly becoming a top priority for today's students (and their families).
This is obvious to anyone who woks in the higher education sector: completing higher education is no longer automatic ticket to a more prosperous and fulfilling life that it used to be, and with the cost of higher education routinely outpacing inflation, people now need to be more discerning about how different educational products generate benefits and lead to a 'return'.
But the public conversation about ROI on education is far from educated. It's actually rather dumb. The more I have seen and listened to people discussing ROI, both publicly and privately, the more troubled I have become about how people are thinking about it.
Most people's notion of where their ROI will come from seems to be either:
an absurdly simplistic calculation of their early-career earnings as a ratio of the course cost; or
an absurdly convoluted ontology of how elite education opens up secret, unquantifiable opportunities that make it justifiable at any cost.
To counter these attitudes, I went looking for a really good guide to ROI on education to start sharing with students, and I came to realise that such a guide didn't exist! Not wanting to leave the issue alone, I decided I'd do my best to make one. This is article is the result.
This is just the first article in a series — because there is simply too much bullshit to unpack in a single article! My first few drafts of this article were 10,000-12,000 words. So I will break up my discoveries into more digestible chunks and I will finish the series by proposing an alternative to ROI which is far more appropriate and easier to calculate.
This first article will answer the following questions:
What is Return on Investment (ROI)?
Generally speaking 'investment' usually means spending some money (or other resources) now to get a larger amount of benefit in the future. Just like when people invest in a rental property or in company stock, they have to outlay money initially to purchase an asset, and then at some later time they will (hopefully) accrue benefits from that asset. Perhaps that's why it uses the word "return" because even though you let go of some of your dollars now, they return to you later on (with some new friends)!
Return on Investment (ROI) is an attempt to measure and evaluate the financial success of an investment. It more or less examines the size of the returns relative to the cost. The end product is expressed as a ratio or percentage, which also means that:
ROI allows you to compare different investments to each other. You can calculate the ROI for all the different investments you’ve made in the past to see which one was the most financially successful. It also helps you to make future decisions. If you are facing a choice between a few possible investments (and you can only choose one), you can estimate the ROI of each, which will tell you which one is most likely to be financially successful.
Can ROI be applied to education?
An ROI calculation can be done on education because, in many ways, buying education is similar to buying an investment. You will need to outlay money initially (your course fees, textbooks, living costs, and so on) in the hope of acquiring an asset (the set of knowledge and skills acquired, which is validated by your certificate, diploma, or degree) which will help you to earn more money (and enjoy other non-monetary benefits too!) at some stage in the future, usually by securing better-paying work.
I really should emphasise — there so much more to education than the financial consequences. And ironically, to get the most value out of education, you have to let go a little and stop obsessing over its financial value. I don't want this article to give you the impression that financial gain is the only — or even the main — benefit of further education. For the avoidance of doubt, I think the financial aspect of education buying decisions is becoming more important as the nature of work and our economy changes, but I also think there's a lot more to maximising value than counting up the dollars. I will be writing about this in future articles but, because the purpose of this article is to help you apply ROI to education, the rest of this piece will make it sound like sound like that's all there is.
Why should you care about your education ROI?
Education is one of the biggest bets you are going to make in your life. The size of the upfront investment you need to make to get a good education — in terms of both money and time/energy — is enormous.
For instance, let's say your typical broad, coming-of-age education course (most likely a bachelor's degree) will require 3-5 years of your time and tens of thousands of dollars (if you are in Australia, which is quite affordable compared to other countries). However, it is increasingly the case that a bachelor's degree is not enough! You may need a masters (2 more years and $40K more) and then professional accreditation (another year and another $10-15K) to truly launch the career you would like. Altogether, in this example, a formal education comprising of bachelors + masters + accreditation is a total commitment of more than $100K and 6 years of time and effort! |
Because the investment in education can be so large, you may find yourself wanting to judge the financial results of your education. This may help you feel some extra confidence that your study choices so far have been the right ones. Or if you are in the earlier stages of your education journey, it can help you to make better choices which might improve the financial results of your education, which is commonly referred to as Return on Investment, or "ROI" for short.
But to be confident you are getting acceptable financial results from your education, you will need a basic sense of your ROI. To do this you will need to understand the key components of ROI and how they fit together, which I cover in the next article on How you can calculate ROI on education.
How is ROI on education calculated?
with education-related examples!
In the previous section we established that investing means using some of your resources now in the hope of getting a larger amount later. The amount you get back relative to how much you initially laid out is the "return".
In an education context that often means spending money on a course now to get a higher paying job later. Depending on what you study, your education might bring you other financial benefits like being able to budget, purchase, negotiate and invest with money more successfully. It might also help you start a successful business and make inordinate amounts of money.
This article will step through the process of calculating ROI. To keep things simple initially, we will start with the assumption that your only cost is the course fee, and your only benefit is a higher paying job. Now we can looks at the benefits relative to the costs.
The mathematical formula for ROI is as follows:
ROI = profit / cost
And because profit = benefits - costs; we can also say
ROI = (benefits - costs) / costs
Let's do a really simple example to illustrate:
Example 1:
Super simple example — ROI on a short course
Your friend says he will pay you $600 to make him a website for his small business. The only problem is, you don't know how to make websites! You research some online courses and realise you can spend $500 on a course to learn website development, after which you can earn the $600 making a website for your friend's business.
The calculation workings are as follows:
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Easy right?!
The reason this example is simple and easy to follow is because it was more like a project than a career. In this example, you spent money once and got paid once. That is how ROI is typically calculated for someone buying and selling an object, like an artwork.
But it doesn’t really reflect how ROI applies to education. In education, you might spend money over a few years before you earning additional money back over, well, the rest of your working life.
So how does ROI work over longer periods of time? Let's look at another, slightly more detailed example.
Example 2:
New example — ROI on an undergraduate degree Please note: I am still over-simplifying in this example to illustrate the concept . A ‘proper’ calculation has many more components which I discuss below in the section called "What it takes to do an accurate ROI calculation for yourself" below. Let’s say you do a 3-year bachelor's degree with full-time equivalent fees of $10,000 per annum (p.a.). The total amount of fees you will pay to get the degree is $30,000. Therefore the COST of your degree (and the cost of your investment) is $30,000. If you never did the degree, your income would have been $50,000 per year. But with the degree you know you can get your income up to $60,000 instead. That means the income you are receiving as a result of your education is $10,000 per year (that's right, it's only the extra income you get from the investment — the income you could already get without the education doesn't count). Five years after completing your studies, you would like to know if doing your degree was 'worth it', so you decide to make that judgement using an ROI calculation. By this point, your money-out, money-in situation in relation to the degree looks something like this: You have still only spent $30,000 on the investment, but you have amassed $50,000 in additional income from the investment. You realise this is enough information to perform an ROI calculation, which goes like this:
Now, if you’ve already been googling the phrase “what is a good ROI in real estate or shares” you will be looking at this number and thinking: education is the greatest investment of all time!!! But there is one further operation we have to perform... If money is earned over many years the ROI is usually expressed as an annual return rather than a total return. To get an average annual return for this case we would divide the total return by the 5 years the investment was active.
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STILL SUPER EASY, RIGHT?!?
Of course it's not!
I understand this looks confusing when you are new to it. So I am going to redo this example once again, but very slowly and using some charts to visually examine each step of the process. If you are already feeling comfortable, you can skip ahead to What it takes to do an accurate ROI calculation for yourself.
Example 2 again (with pictures!):
You may recall in this example you did a three-year bachelor's degree which cost $10,000 per year (in the chart below, these are the first three red columns), and once you completed the course, you secured a better job where your annual salary was $10,000 higher (these are the ongoing green columns).
Looking at the diagram we could guess that, at face-value, the degree was a good financial decision (because there's more green stuff than red stuff in the picture, right!); but until we do some calculations we can't be completely sure this is correct.
We will definitely do some calculations, but before diving into those, let's add in one more piece of the picture: cumulative cash flow. This is the accumulated value of adding and substracting the costs and benefits over the life of the project (for more, see article or video).
Another way to think cumulative cash flow about it is to imagine you were able to open up a bank account for your degree, where:
the account could only process payments - both to you (as income) and from you (as costs) - which specifically related to that degree. You couldn't use the bank account for any other purpose; and
all of the payments relating to the degree must go to/from that bank account.
In other words, every dollar relating to the degree passed through the bank account.
This chart is depicting the flow of monies in the bank account for our example. Our three first three years of paying for the degree are still shown in red, and our five year income boost is still coming into the account in green, but now we are also tracking the cumulative cash flow - our bank account balance - which is in yellow.
The yellow line is a running total (cumulative) of how much worse/better off you are from the investment. If we wanted to, we could also use the yellow line to try and guess if the course was a good financial decision or not (if it goes above zero, great! If it goes really high, that's really great!). And using this would be a little bit more accurate than guessing from the size of red and green columns. But what the cumulative cash flow line also shows us is that the return on investment looks very different for us at different stages of the journey. For instance:
Things look rather bleak when the costs are piling up over the first three years!
But at some point you start earning more money from the investment than it is costing you to have the investment in place. That's the point where the line changes direction and starts going up.
After a while, your investment starts giving you back more money in total than what it cost you. This is when the line crosses the axis at zero.
To show a final chart, we will add in the actual Return on Investment calculation from our first look at this example above, which is shown in blue.
Because the yellow line and the blue line are different ways to express the same idea, you will notice they have the same shape and trajectory. They both try to answer the question 'overall, how is this investment going?', but the blue line uses percentages whereas the yellow uses dollars. As is mentioned in the introduction, the per cent expression, Return on Investment, is more useful to us because it allows us to compare different investments to one another.
What it takes to do an accurate ROI calculation on education for yourself
A rough ROI calculation is easy, but a completely accurate one demands a great deal of careful and time-consuming research (and is still generally not possible, because some variables have to be estimated). There are a lot of variables to consider and treating any one of them poorly can distort the picture and mislead you. I will describe the main ones to consider here:
The cost of living while pursuing further education. This would need to be added to your cost of education. In particular you would need to track or estimate only those costs that are incurred from the education. If you would have incurred the cost anyway even if you never decided to study (like a phone bill), then these are not part of the costs of your education. Most people do not track their living expenses this way, so you would need to make a huge budget with all your expenses line-by-line and classify them as education-related or not.
The cost of borrowing money for your education. When you borrow money this will come at some kind of additional cost (usually this takes the form of paying interest on the loan balance over time) and also needs to be reflected in your overall calculation. The cost of borrowing can will most likely affect the 'profit' from your education as the cost is incurred each year as the interest is charged to you over time, eating into the gains in your income. If you are eligible for government loan systems like the HELP scheme remember that these are not entirely free — there is still a cost you will need to factor into your calculation - and so you won’t be able to ignore the cost of borrowing completely.
The opportunity cost of pursuing further education. Opportunity cost is a slightly abstract concept from economics which you can learn more about from Wikipedia and Investopedia, but basically means quantifying the best alternative you could have chosen and treating it as a cost. If we were fully incorporating opportunity cost into the example above, not only would we exclude the income you would have earned anyway if you never studied from the benefits side of the calculation, but we would add this amount to your cost side! That's right, the opportunity cost includes all the money you could have earned but didn't because you were studying — your next best option and the ultimate cost of forgoing that 'opportunity'. Opportunity cost is a way of establishing that your chosen course of action (no pun intended) was the best option and by how much. A big challenge you are going to have wrapping this into your own education ROI calculations is estimating what your income would have been without the education. In my experience this is pure guesswork.
The income derived from the course. Remember that benefits in your ROI equation is generally only the income you would not have been able to obtain without the further education. Now that you understand opportunity cost, you will know that it is too hard to justify using your total income in the ROI calculation, because a chunk of it was already obtainable without the course of study. For instance, if part of your income is driving Uber on the weekends, this should not be counted. But if you got a day job you couldn’t possibly have obtained without the education, like being an optometrist, a significant part of this income should be included. But it begs the question: exactly how much? Should you only include the net of what your salary would be if you never studied (yes, that is my view)? And if so, how on earth are you ever going to estimate what you 'would have' earned in the number of years that have elapsed. These can be estimated, but the more of an estimate they are (in contrast to facts), the more your ROI number will be an estimate as well (in contrast to a calculation).
The impact of taxation. When you earn money you will pay tax from those earnings. And if your education raises the amount of money you earn, you may not only need to pay the same rate of tax on those extra dollars you are earning, but it may push you into an entirely new category of taxpayer where you are taxed differently (in Australia we often say you’ve entered another “tax bracket”, after your income crosses another “threshold”). When you are calculating your additional income from education, if the increased income you are forecasting will raise the amount and rate of tax you are paying, you will need to decide if you want to evaluate the pre- or post-tax impact of further study. When comparing investments to one another, this is generally done pre-tax but before making final investing decisions it's important to check the known impact of taxation. I think it makes sense to do the same when buying education. But you should keep in mind that the eventual difference in your wealth will of course be post-taxation.
Inflation and the time value of money. It will be unproductive for me to explain what these concepts are if you are not familiar with them already, so if you are unsure take a look at the Investopedia articles for inflation and for time value of money as a starting point. For those who do know, they’ll remember that the purchasing power of a dollar declines over time which means the value of the money you spent on education in the earlier years — per dollar — is more than the value of money you receive back in the later years — per dollar — because the value of dollars themselves has declined. You will therefore need to identify an appropriate discount rate to apply to your calculation so you are working with comparable dollar values (usually in "present value").
The impact of subsidies and scholarships. The impact of these should be rather obvious — they will reduce the cost of your investment. When calculating your the cost of your investment, you should really only count the costs that you (as in, you the individual) have incurred. If you received a $10,000 scholarship, or you received $50,000 in fee remission, or any other such discount or gift, you should be taking the same amount away from your cost calculations. In some cases, scholarships can lead to higher income — perhaps a large and famous merit scholarship also provides you with extensive tutoring, networking and mentoring in addition to the funds, and these things will likely lead to some better job outcomes — but if this occurs it will be reflected in your future income itself. There is no need to attempt to quantify these gains upfront.
As you can see, an 'accurate' calculation of your Return on Investment becomes very detailed and very personalised very quickly, and it asks you to make a great deal of assumptions that may turn out to be untrue. You will need to be extremely committed to the integrity of the exercise to work your way through all of these variables and reach a complete and highly accurate number.
Knowing this may lead you to ask:
If these calculations are so individualised... why should I believe any articles comparing ROI across different courses and institutions?
The answer to this is question complicated and will be addressed in appropriate depth in the next article.
The short answer, for now, is that these articles are generally calculating an average ROI using a rather flawed method along the lines of total salary / cost. In my opinion these are:
not a reliable indicator of what return you could or should expect; because
they are not ROI calculations; instead
they are substituting in a concept which is related but easier-to-measure called "returns to education" which examines the price of educated labour.
So altogether, you can be curious and take the clickbait to see which institutions stack up the best (I certainly do!), but don't put too much faith in this type of information and definitely don't rely on it in your decision-making.
In the next article, I will explore how you can develop better expectations for your education ROI — ones that will actually help you evaluate different education options and make decisions about what education you should pursue in real time.
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