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Fool Blog: Is Tuition the Next Bubble to Pop?

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Remember that queasy feeling you got whenever you heard someone advise you that, "In 20 years, the cost of a four-year private college education will be a half-million dollars, so start saving aggressively!"?

Those scary predictions weren't pulled from thin air. Between 1989 and 2005, college costs increased at double the rate of inflation, according to American magazine. At that rate (about 6%), compounded over 20 years, annual tuition at private institutions George Washington University and Sarah Lawrence College, for instance, would end up being $129,543 and $126,521, respectively, by 2028.

But let your tummy settle, because that's simply not going to happen.

Here's why
College tuition skyrocketed in the past 10 years or so, largely because of the convergence of rapid technological change, the increasing need for a college degree in a service-based economy, and cheap and easy credit. Colleges frequently cited "infrastructure" and "technology" improvements to explain the 6% annual tuition increases. But now that colleges are largely wired and wireless, it's doubtful they'll be able to keep using those reasons.

Additionally, if the credit markets do in fact dry up as much as some believe, families will simply be unable to secure those enormous loans for school. According to FinAid.com, about two-thirds of college students use loans to pay for college, leaving them with an average debt load of $19,000. The recent turmoil with credit markets has to be disconcerting for parents with kids currently or soon to be in college.

Even if the credit markets are fully restored by 2028, there are still very few people who have the means -- or desire -- to fork over a half-million dollars for their child's education. And even if they could come up with $100,000, there's little chance they'd be able to secure a $400,000 loan. Lots of people can't get mortgages that big.

Bright flight
Along this line of logic, bright students who had previously been vying to get into highly regarded private colleges, only to find out they couldn't afford tuition, may start flooding the less-expensive state schools. As a result, the average test scores of private schools may suffer, while those at the public schools improve, thus putting costly private education in less demand.

Harvard University has already begun taking steps to keep the top students coming through its doors. In December, armed with its $37 billion endowment fund, the university announced that it would spend an additional $22 million a year to slash tuition costs for middle- and upper-middle-class families, in some cases reducing tuition from $30,000 to $18,000 for a family making $180,000 a year. Unfortunately, not all private schools have such a large endowment to tap when things get rough.

Finally, at some point, the return on investment for an education with a large price tag becomes negative, and people will find alternative routes to higher education, whether that be trade school or local community colleges (both very respectable choices). See, the math for continuous 6% tuition hikes just doesn't add up. In good times, the annual starting salaries for college grads will likely increase by just 3%-4%. Eventually, it won't make sense from a career standpoint to attend expensive four-year colleges.

What this means for you
At some point, the tuition bubble has to give. It's simply unsustainable for universities to continue to raise tuition 6% per year, and it's a situation that college presidents need to address immediately.

Now, this doesn't mean that you should be saving any less for your kids' college tuition, but it does mean that you may not need to be taking undue, overly aggressive risks with the kids' investments.

College will still be expensive going forward, but it certainly won't be as pricey as some may have thought in the past. So don't feel like you have to roll the dice on high-growth stocks like salesforce.com (NYSE: CRM  ) or once-hot sector plays like coal maker Alpha Natural Resources (NYSE: ANR  ) with your entire college portfolio.

Instead, consider a more conservative mix of stocks. Big, well-known companies like Johnson & Johnson (NYSE: JNJ  ) , Procter & Gamble (NYSE: PG  ) , and Wal-Mart (NYSE: WMT  ) make a good foundation for a portfolio. Mid caps like Coach (NYSE: COH  ) and BJ Services (NYSE: BJS  ) add diversity. This type of broad-based equity portfolio, paired with some fixed-income investments as college gets closer, is the smarter and more conservative way to save for college.

Johnson & Johnson is a Motley Fool Income Investor selection. Wal-Mart is a Motley Fool Inside Value pick. Coach is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days. It's what all the smart kids are doing.

Todd Wenning is a private school grad and owns shares of Procter & Gamble. The Fool's disclosure policy graduated with honors.


Read/Post Comments (4) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 02, 2008, at 10:32 AM, tfarnham wrote:

    Excellent thoughts about rising tuition and sustainability. In addition, there are significant variables that will force lower tuition in less than ten years through competition. Learning technology (not necessarily teaching) is quickly improving at an increasing rate. It is being developed by innovators in home schooling, Charter Schools, technical training, pre-K education, home-bound and special needs students. The traditional classroom model, especially in private residential colleges, will have to compete against effective learner and technology based environments with perhaps a cost advantage of four to one or more. This potentially could be very disruptive in only a few years. The past may not be prologue. Remember Wang, Digital Equipment Corp., Harris, Prime minicomputer companies? It took less than fifteen years for the lowly PC first used by hobbyists to displace these once might companies.

  • Report this Comment On October 06, 2008, at 7:21 AM, edububble wrote:

    This is a very nice, concise description of the problem I described in my book, "Beating the College Bubble." (www.edububble.com) My version is much longer, but it doesn't take much thought to see the parallels between the real estate market and the pricing of college degrees. Excess debt and a cavalier belief in asset appreciation are the two ingredients you need for an irrational explosion in prices. What do you know, you've got them here.

    The tricky question is how to survive the bubble pop. It won't go whoosh like the stock market. It will take years for the correction to work its way through the system. And, to make matters worse, an expensive degree is still worth it for some people. Not many, but some. How do you know if you're the one who should still believe in the high priced dream?

  • Report this Comment On August 17, 2009, at 6:00 PM, rfaramir wrote:

    So long as the government subsidizes higher education, its cost will escalate. Just like the housing bubble.

  • Report this Comment On September 15, 2009, at 11:33 AM, WmSchick wrote:

    These outrageous tuitions are another way that The Man is sucking capital out of the middle class. Eventually the bubble will burst. But not until everyone's out of money bc., like health care, people are willing to pay whatever it takes to send junior to a good school (just as they are willing to pay whatever it takes for health care) and, again, the govt is subsidizing it. One other tidbit--the higher ed. lobby is quite strong. College professors are probably as strong as the unions within ObamaNation.

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