Monday, October 3, 2011

Investing for A College Education

My wife and I took our daughter Caroline for a visit out to the University of Michigan last weekend.

This excursion was a real treat for me. I graduated from Michigan in 1978, and with the exception of a few trips shortly after graduation, have not had the chance to return to Ann Arbor in over 30 years.

Caroline is a senior in high school, and is currently immersed in the college application process. She's also a good student, and is interested in biomedical engineering. We've visited a number of schools over the last few months, and she is quickly narrowing down the list of schools to which she is planning on applying.

(Caroline is also pretty savvy in dealing with her father, and let me know that while she had a very good impression of Michigan, she had not yet made up her mind.)

We had a great weekend, despite the cold weather that had come too early to Ann Arbor. Even my wife - a graduate of Colby College - was impressed, including the experience of attending a football game with 100,000+ Maize-and-Blue fans.

Besides offering a very nice trip down memory lane, the trip was an eye-opener for me in terms of how much the Michigan experience now costs students and their families.

Attending Michigan is not cheap, especially for out-of-state attendees. Michigan estimates that the full cost for one year for someone who is not a resident of the state of Michigan is in excess of $50,000 per year, which puts it in the same expense category as most of the Ivy League and elite East Coast schools.

By comparison, when I attended Michigan in the 1970's, the full cost was $5,000 per year, even though I too was not from the state.

Put another way, if Caroline attends Michigan, we will pay $45,000 more per year for essentially the same education experience as I had 33 years ago.

Michigan and other top-level schools can charge this tuition because there are so many families that are willing to pay this amount.

My alma mater said that it received over 40,000 applications for admission last year. The average GPA for this year's freshman class (which totaled around 6,800 in size) was 3.8 out of a scale of 4.0, and the median board scores were top quartile.

In other words, it seems unlikely that tuitions are going to fall any time soon, since demand for admittance from top-flight applicants is so strong.

The increase in tuition expenses amounts to a growth rate of 7.2% per annum, which is higher than the rate of inflation over the same time period.

So why am I bringing all of this up?

Well, if you have younger children who hopefully someday will attend a prestigious school like UM, you probably are investing money in something like a 529 plan. And you're probably facing one of the most difficult investing environments in the past few decades.

In my opinion, with bond yields below 2%, and cash returns mostly below 1%, the only asset class that will at least offer the possibility of matching the rate of growth in tuitions for the next decade or so is dividend-paying common stocks.

My opinion is really just based on math. The price/earnings ratio of the S&P 500 is around 11x trailing 12 month earnings, which is around the historic average. If stock prices can track the historic book value growth of around 5-6% per year, and dividends remain around 2% or so, it seems reasonable to expect that a longer term return for stocks should at least match the growth of costs of attending college.

In the meantime: Go Blue!