Wednesday, June 15, 2011

But you're going to make tons of money, quit worrying!

The most common argument I'm hearing against my goal to graduate debt free is that it doesn't really matter.  That I'll be like Croesus after graduating, rolling in so much money that six figures of student loans will just be a drop in the bucket for me, insignificant to pay off. Don't worry about student loans, they're a great investment and you'll be making $150,000, $250,000, or $300,000 after graduation and more as you go on.

First, let's address the idea that student loans can be an investment.  Allow me a moment on my soap box here - I have a bit of a pet peeve.  I recently wrote about this in the comments of another post
I think the MBA degree may be a good investment and degrees in general may be good or bad investments, but the student loans are only a method of financing. The student loans are never an investment in and of themselves and if they were they would be a terrible one since they have a negative return.

Like a mortgage on a house, student loans can only reduce your return on investment since you will be paying significant interest on them eating into any gains you have. In some cases you may still be left with a positive ROI, but it will always be smaller than if you had paid with cash.

The only benefits to student loans, buying on margin, and other debt is their ability to leverage what assets you have to provide greater opportunity. So while you may not be able to get the degree without student loans and obtain the maximum ROI you can still potentially use them to obtain the reduced ROI which is better than no ROI. Debt also allows you to minimize opportunity cost which can be helpful if you can pay for an asset in cash, but could gain a bigger return elsewhere (ie student loans are 7%, but you could get a 16% return elsewhere giving you an over simplified profit of 9% minus fees etc). The latter is not the case for most students, but the former might be if the degree is a good investment. 
The point is, unless you have an amazing alternative investment and tons of cash (in which case send some of your good luck my way), student loans will NEVER be as good as NOT having student loans. Student loans are not the investment, your degree is. The other important note is that when you leverage debt you are also leveraging risk which reduces the value of your return on investment relative to a safe bet.

Okay, now that I'm off my soap box (sort of, am I ever really off my soap box here? I guess that's partly what blogging's about) let's move on to the income side of the argument, the part that says student loans won't matter because I'll be making so much money.  Boy, oh boy do I hope these guys are right.  I would love to be working in a job I love and making a quarter of a million dollars a year shortly after graduating.  I may be frugal but that just makes me better at using large sums of money. ;)  I could definitely find a use for that much money without student loans to pay down.

But there is one big problem.  Money is never guaranteed.  I've met people who graduated from Harvard Business School and Stanford, but could not find a suitable job for months after graduation.  I'll agree that it's likely I'll be able to find a well paying job after graduation but it is also in no way guaranteed.  The typical starting salaries are also not as lofty as some might think.  US News puts Stanford and Harvard at the top of their MBA rankings so they may have some of the highest starting salaries, but the median starting salary at Stanford is $120,000 and Harvard's is $110,000 which is significantly lower than some of the income numbers that have been tossed around on the blog.  Sure there are some way bigger numbers on the high end but there are also plenty of numbers way smaller than this.   Salaries are also tightly clustered around the median - 50% of Harvard grads have salaries between $100,000 and $125,000, with 25% falling below and 25% above.

So a salary of $120,000 is big, really big compared to the American average, but it's still not enough to make a typical student debt load seem insignificant.  A salary of $120,000 isn't enough to make debt of over $70,000 seem insignificant.  I'd be scared to have $35,000 of debt on a $60,000 salary or worse $17,500 of debt while only making $30,000.  A higher income does mean more truly disposable income, but it also means lifestyle inflation for a lot of people as well as higher taxes.  Either way it's still not enough to make your typical student loan burden evaporate.

The income argument also assumes that you'll be making the big bucks for as long as you have student loan balance.  To make this true you have to be lucky with layoffs, burnout, and motivation to be in that kind of position. This would need to be 10, 20 or 30 years depending on how your loans are set up and if you just pay your minimum payments or add more (in which case those numbers would all go down).  Let's say you graduate from business school at, say, age 28.  Worst case scenario you could be just polishing off your student loan payments at age 58! I don't know about you, but I'd kind of like to be in a position to retire if I wanted to before then, which means no debt and fixed payments would be awfully nice.

So to my thinking in the vast majority of business school graduates' financial lives (and I would wager this holds true for medical and law school graduates as well) it absolutely does make sense to worry about student loans and try to avoid them.  Particularly once you factor in that with student loans you can end up paying for your degree twice or more.

What do you think?  Though I write a lot about student loans for the blog here, I'm hardly in a panic or a lather about them all the time in real life, I just think student debt can be destructive and should be avoided.  Am I over reacting?

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  1. I just read somewhere (I don't think it was here) that a reasonable number for total student loans is half of what you think you can make in your first year after graduating, so if you think you can make $60,000, you could 'handle' $30,000 worth of loans. It seems when you looked at numbers that would start making you nervous, the percentages were above that line, so maybe there's something to that.

  2. I tend to error on the side of favoring certain types of debt. But student loan debt, regardless of how small, low-interest, and tax-advantaged, is still debt that you can never charge off.

    I like debts that leave some flexibility. Student loans are no such loans.

  3. Even if you are making $100,000+ after b-school having student loans takes a certain amount of freedom from you.

    There's no guarantee you'll be passionate or enjoy your new post-MBA role but you'll have a lot of pressure to stay in it for the $$ regardless if you have a heavy debt load.

    Being debt free or as close to it as possible allows you to be more flexible and free with life/career decisions.

  4. Money Beagle - I think you're right that there is a threshold where the debt to income ratio becomes unpalatable. Personally I think mine is much lower than 50%, but 50% is a point at which it seems to become significantly risky in my mind.

    JT and Money in Your 20s - You guys are hitting on two of the major reasons why I'm trying to avoid taking on student loans. In the end it's all about having options and flexibility in life, right?

  5. I think student loan debt is really one of the worst kinds of debt possible, since you can never ditch it. Also, we give really young adults a ton of money with the expectation they will be able to repay it. How does this make sense?

  6. I think you are wise to want to minimize or totally graduate debt free!

    As finance folk, we know that debt sucks and paying debt instead of investing is no way to because wealthy...

    Besides times are tough and unemployment is still higher than normal...

  7. I think student loan debt is a big bummer. I paid for my undergrad and MBA all on my own and it took awhile to get rid of the debt when starting out.

    I wonder if the high average salary of those Harvard grads is also because many of them settle in big, expensive cities like New York. (Boston isn't cheap either.)

    I would never take on extra debt today for the possibility of future riches tomorrow. Not to say borrowing for education is a bad thing, I did it. However, I went to a school that was reasonably priced and I had much less debt than if I had gone to a private school.

  8. Everyday Tips - You're hitting on a point that I think is really key - school choice is super important. It's the biggest factor in cost, the biggest factor, with degree choice, in ROI, and it's all under your control.

    Congrats on paying your own way for both degrees. It's not easy.

    Harvard actually publishes data on salary vs location. Go to their salary data page ( and scroll down to "Class of 2010 Career Salary Statistics by Location".

    "Other South" looks like the lowest median salary in the US at $100k while "Other New England" is the highest at $122k. So the salaries are actually probably very tightly clustered regardless of location which I find interesting. Maybe I should be shooting for a low cost of living area out of my MBA. As long as it's not India - the median there is $63,000. No idea how you make the MBA pay off that way.