Economists mislead families by framing college attendance as an issue of capital investment rather than one of affordability. Telling parents and students that they should choose the college with the highest net present value, or predicted return on their tuition investment, encourages them to choose the most expensive college they can. Since colleges work to convince the public that quality and cost are directly correlated, the investment framework is a good complement to marketing strategies.
In fact, no objective data support the hypothesis that higher cost means higher quality in education. The data are lacking because colleges and universities provide few objective measures of quality, even though the market has called for that evidence for decades.
Colleges have no incentive to provide high-quality information and every incentive to keep "quality" measured by soft, ambiguous rhetoric. Colleges benefit when the public is uncertain in that regard: As long as people cannot measure the quality provided by individual institutions, they cannot make rational cost decisions among competing enrollment options.
The coupling of the investment model with college choice makes families less price-resistant than they should be, which in turn facilitates colleges' ability to increase the price of attendance. The result is three decades of unprecedented increases in the net price of attendance, and record levels of student debt.
In order to make an informed investment decision, the student "investor" must be able to make accurate economic forecasts, properly estimate the probability that he or she will graduate, predict the completion date, choose the right major, and understand how to calculate the investment's value. Yet calculations based on flawed forecasts and erroneous probabilities are worthless, if not dangerous, and the information and sophistication required to make the right choice using that method are beyond the capabilities of most families.
In contrast, the affordability model is simple and requires only that a family know its current financial condition. No forecast of future prospects or estimation of probabilities is necessary. Family members consider how many children will be going to college, family savings, current income, parents' retirement expectations, and whether each student will be able to work in the summer and/or after classes. From this they work backward to agree on the maximum amount they can spend, whether from earnings, savings, or debt, to pay for college. And they can apply this method to each successive year of attendance until the student graduates. This strategy minimizes household regrets: If the student cannot finish or is unable to work after college, the financial impact on the family is mitigated.
The difference between the investment and the affordability models is subtle but important. For example, financial studies show that individual investors are best served by purchasing broad-based indexed stock or bond funds and/or exchange-traded funds. Doing so, they achieve instant diversification, with the lowest possible fees, and avoid having to do an analysis of any individual security. They can apply the affordability model to stock-and-bond investments by calculating how much to contribute to those investments during each time period. In essence, this strategy converts investors' decisions into an affordability issue.
Similarly, consider the residential-real-estate market before and after the 1990s. Before then, purchasing a home was strictly an affordability issue, and that model was imposed on homeowners by lenders who expected to hold on to the mortgage. Lenders required data on borrowers' income, existing debt, credit history, and family status in order to determine how much they could safely afford to borrow. Hence the lenders put a price ceiling on how much individuals could pay for a house; they were subject to a binding price constraint on their home purchase.
For a variety of reasons, this changed during the 1990s. The mortgage-repackaging business sent a flood of new money into housing, and original lenders could resell mortgages to others, who bundled those mortgages and resold them as mortgage-backed securities. With borrowing constraints lifted, prospective homeowners approached the purchase of a home as a capital-investment decision, which says buy the asset with the highest net present value—and that means buy the most expensive house they could.
It followed naturally that borrowers bought more house than they could afford. Housing prices were artificially inflated, "flipping" houses became common, and the housing bubble grew. Eventually, of course, affordability asserted itself, and the bubble burst. In other words, the shift from the affordability model to the investment model in housing led directly to the great recession of 2008.
If the investment model is inappropriate for homeownership and stock-and-bond investing decisions, it most assuredly is inappropriate for college-attendance decisions. The homeowner takes possession of the asset when it is purchased; the student does not take possession of the asset, if ever, until some graduation date to come. The homeowner has an estimate of the asset's value at the time of possession, while the student does not have a realistic estimate of the asset's value until several years after graduation. A home is a real asset; a homeowner can recover part of his investment by selling the asset. A college degree is an intangible asset; it cannot be resold.
Studies of the "return on investment" for a college education generally consider only those who complete college, which is hardly everyone who attends. Even for those who graduate, studies report results for the average or median students, while the distribution of results has considerable variance. Further, the return on investment is conditional on native ability, preparation, motivation, and the major chosen.
It is a mistake to encourage all students to go to college—and it is a mistake to encourage families to spend more on college than they can afford. For students in the upper half of the distribution of ability, preparation, and motivation, spending more than they should for college does not do serious damage to their long-term financial status. For those students in the lower half, the impact of spending more than necessary for college can be devastating.
College attendance should not be promoted by the investment model any more than homeowners and retail investors should make their choices based on a speculative net present value. After all, risk is positively correlated with rate of return. Paying too much for college is a risky choice.