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How Do We Calculate College ROI?

In conjunction with Bloomberg BusinessWeek, PayScale recently released our third annual College Return on Investment (ROI) Report, which evaluates the financial return for a bachelor's degree from 853 U.S. schools.

With this study, we hoped to lend our voice to the related debates around the looming student debt bubble, tuition costs rising faster than inflation, and the increased frequency with which recent college graduates are unemployed and underemployed.

The general conclusion of the PayScale College ROI Report is there is high variability in the return on investment in education and that a college education doesn't always pay.

In addition to a debate, our report seems to have spurned numerous critiques of our methodology that have resulted in false interpretations of our methods.

We stand behind our methodology and are happy to explain it. We also welcome feedback to continue to improve the report. Our goal is simply to arm prospective college students with the information they need to make informed choices about college. We recognize that the potential financial benefits of college are not the only benefits. However, they are a significant factor, and it is the piece of the equation where we are qualified to offer insight. College – whether and where to attend – is a difficult decision, and we believe anyone considering it should have all the information available to make the best choice for them.

In this blog post I will cover the basics of our methodology for the College ROI Report, and in the following post I will address the specific criticisms we’ve heard about the College ROI Report.

College ROI: Basic Methodology

For an in-depth discussion of our methodology, please see this link on the PayScale website, as well as an article run by Bloomberg Businessweek. Calculating a return on investment is a complicated endeavor, and for a detailed description of our methodology, reference the above links. In this post, I want to talk generally about what we did and how we did it.

When calculating the return on any investment, you have to consider your costs (investment) and your expected return. When it comes to college, the costs are two-fold: 1) the actual cost of paying for education (tuition & fees, room & board, and books & supplies) and 2) the foregone wages from choosing to attend college rather than working straight out of high school. The return from attending college is simply the wages earned after graduating.

Therefore, in simple terms, the ROI of college is the difference between the wages earned and the costs (both direct and indirect) incurred.

One additional factor complicates this further not everybody who attends college graduates. Therefore, our ROI measure also takes into account graduation rates. The way we do this is to weight the ROI by the overall (6-year) graduation rate of the school. The idea being that schools with low graduation rates are penalized in the ROI measures, while schools with high graduation rates are not. Everyone that attends college believes they will graduate, but that’s simply not the case, and we believe it would be irresponsible not to address graduation rates in our calculation.

College ROI: Cost Measures

There are numerous permutations of cost structures faced by college students. Some pay full sticker price, some take out private loans, some receive federal loans, some earn scholarships (academic, sports, and other forms) and some use a combination of the above.

Since representing all cost structures faced by students is impossible, we focus on two measures that use publicly available data from the Integrated Postsecondary Education Data System (IPEDS), which is run by the Department of Education:

  1. Full sticker price paid by students who live on-campus for their entire college career.
    • This price incorporates tuition & fees, room & board, and books & supplies.
  2. Net price paid by students who live on-campus for their entire college career.
    • This price incorporates the average annual grant aid received by students at the school, where the grant aid includes local, state, federal and institutional grants.
    • It is simply the difference between the full sticker price and the average grant aid multiplied by every year of attendance.
    • Please note that at the time of data collection, the most recent grant aid data available was for the academic year 2008-2009.

For both of these costs, we calculate the in-state tuition cost and the out-of-state tuition cost for every public school on the list.

In previous years, when calculating the typical cost of a school, we deemed schools to be 4-year, 5-year or 6-year schools depending on the length of time taken to graduate by the majority of their students. Schools that were on the border between four and five years of costs or on the border between five and six years of costs might have faced unfair cost representations.

For this reason, we changed our methodology to focus on the weighted cost of attending. This weighted cost accounts for how long it takes actual graduates to graduate by using the 4-, 5- and 6-year graduation rates in the cost calculation. Note: Since not everybody graduates, we are explicitly concerned with how long it takes those who do graduate to do so, rather than the graduation rates of all students, which incorporates graduates and non-graduates.

For example, assume we have a school with a 45 percent 4-year graduation rate, a 65 percent 5-year graduation rate and an 80 percent 6-year graduation rate. Then, of those who graduate, 56 percent do so in four years, 25 percent do so in five years and 19 percent do so in six years. Now, for simplicity, let us assume the total cost for each academic year is simply $10,000. Then the 4-, 5-, and 6-year costs would be $40,000, $50,000, and $60,000.

Using these figures we can calculate the weighted cost: (56% * $40,000)+(25% * $50,000)+(19% * $60,000) = $46,250.

Note that this cost is roughly between the 4-year and 5-year cost since the majority of those who do graduate do so in four or five years.

For schools where the majority of undergraduate students graduate by a particular year of attendance (e.g. the majority graduate by their fourth year), this weighted calculation will have little to no effect on the cost reported as opposed to a straight summation of the total cost. The effect will be seen for schools where the percentage that graduate in four, five, or six years is fairly split.

College ROI: Income Measures

There have been a lot of questions around where we get our alumni income numbers. The answer is they come from the profiles of people who have completed an online salary survey at PayScale.com.

People come to our survey to price themselves within the labor market. The survey asks questions about compensable factors that influence pay, such as experience level, location of work, common skills and certifications, etc. In the survey, we also ask people about their educational background (school, degree, major and year graduated).

Since the main motivator for completing a PayScale survey is to find your labor market price, the school data is secondary. Therefore, we don’t suffer from the “happy alumni bias.” This bias typically exists when schools survey their own alumni, as the majority of respondents are those with success stories. In other words, if an alumnus went to Harvard, got a degree in English and now works as a barista, they are likely not to inform their school. However, in our case, we get data from both groups: the success stories and those whose school backgrounds do not match their current career choices.

Another question we've received is, how are we measuring the expected 30-year median pay for a graduate in 2011? The simple answer is we are using past graduates to predict what future graduates might earn.

In more specific terms, what we did was sum up the median pay for bachelor graduates who graduated between 1982 and 2011 from a given school. Please note that we are using data collected over the last year so these earning figures are in current dollars.

This method means we are essentially taking future potential earnings and deflating them down to current dollars by wage inflation. In other words, this amount represents a present value of future earnings discounted by wage inflation.

There is one minor flaw in this approach that we will readily admit. This method assumes earnings 30 years from now for a 2011 graduate are the same as the current earnings of a 1982 graduate. However, if the character of a school's graduates changed significantly over the last 30 years, this measure may be inaccurate. That being said, no one possesses a crystal ball and the best anyone can do is make an informed estimate of what the future may entail by using past information.

Understanding the methodology of a study is key to understanding the conclusions of that study. In my next blog post, I will address some of the inaccurate conclusions others have drawn about the College ROI Report, due to misunderstanding the methodology.

In the meantime, when you want powerful salary data and comparisons customized for your exact position or job offer, be sure to build a complete profile by taking PayScale's full salary survey.

Regards,

Katie Bardaro
Analytics Manager, PayScale, Inc.

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