Tuesday, January 8, 2008

Tuition Enigma

You are the parent of a two year old. Although your child still teeters with each step and thinks lunch is a face paint, you are already beginning to navigate the financial shoals of saving for a college education. How much will it cost?

Imagine you are shopping for groceries. You look through the window and see attractive displays of fruits, vegetables and packaged goods. The prices are clearly posted, but many are extremely high. You swipe your ID as you enter the store and the prices suddenly begin to jump like the scale on Biggest Loser. The grocery store has just checked your credit rating and repriced its inventory based on your ability to pay. If you are well off, the prices don't move at all. If you are poor, most of them drop substantially, with the expensive items, the elite private schools, those Fillet Mignon of the collegiate grocery, dropping the most and a few staples, the community colleges, the oat meals of academia, barely budging.

Harvard, Williams and their ilk could fill their entering classes with the children of the rich, who would be more than willing to pay the full posted price, but, after a century or two of offering scholarships to the extremely talented few, elite schools like these decided that in the event of class warfare they did not want to be on the side with fewer troops. Thus a policy of financial aid based on need developed. The elite would offer admission based on "credentials" (credentials could still include things like the ability to run with the football or the fact that the applicant's father was an alumni and head of the CIA) and, if the applicant's family could not afford the tuition, the school would provide financial aid to offset tuition and room and board bills by just enough so the applicant could attend while his parents stayed (barely) out of the poorhouse. The Ivy League, in collaboration with MIT (someone had to do the math), actually set up a trade association to determine the financial need of applicants on a collective basis.

The US Justice Department, taking the view that the true price of a college education was the posted tuition less financial aid, attacked this collaborative evaluation as a form of price fixing. College education is not a simple commodity. Some students will gladly pay twenty times as much to go to Harvard as to Boston College, others pick State U over Harvard without regard to the price. Tuition, even the net or effective tuition after deducting financial aid, is just not the key factor in their decision. Despite the fact that the market for college educations has some unusual features, As Good As News belatedly concedes the Justice Department had a point. First, a better aid package might make a difference to a student choosing between Harvard and Yale, even if the same student would spurn Boston College at any price. Second, the action by the Justice Department foreshadowed, and may have contributed to, a change in the student aid climate.

A network of colleges built to serve a baby boom size population suddenly found itself with a shrinking universe of applicants. Meanwhile, the grown up boomers put greater emphasis on the prestige of the colleges their children would attend. The result? Colleges, especially private colleges, needed students, preferably students with high SATs and GPAs that would enhance the reputation and rating of the college itself. To attract students they began offering merit scholarships on a widespread basis. A lucky few would get the coveted full ride, joining the athletic royalty, but for many an award of five or ten thousand dollars a year in scholarship money would make a difference in selecting a college.

Returning to our collegiate grocery store, for the last ten or fifteen years the prices have moved twice. Once, based on need, when we enter and undergo the credit evaluation. A second time, based on merit, when we approach the check out counter with our child's report cards and test scores in hand. The Fillet Mignon price is not moving very much on checkout because of merit aid, because Harvard and Williams don't need to lower prices to get quality students. The oatmeal price is not moving either, but the lamb chops, the fresh vegetables and even some very nice roasts and salmon fillets are sold at a discount, because even some good schools will compete to get the students they want. Sometimes it's an across the board cut, like the University of Vermont with its formulaic merit awards. Sometimes it's a negotiation with the admitted student playing two financial aid offices off against one another. Either way, the posted tuition means less than ever and even Richie Rich can get a discount if he's a good student.

Very recently some of the Fillet Mignon has been marked down to new lower prices in a trend that may spread, a little. Harvard and Yale have both announced that they will make more aid available to more admitted students. In Harvard's case the poverty line for aid qualification will now include families with a six figure annual income. This is still need based aid, these institutions do not need to discount to get quality students and would not admit it if they did, but, in addition to any possible covert competition for quality students, there is a new factor at work. The endowments at Harvard and Yale are producing so much income the schools need to spend it.

Charitable foundations are generally required to spend at least a certain percentage of their income on charitable pursuits or lose their tax exemption. After all, they are supposed to be charities, not hedge funds. College endowments are not subject to this rule, but they could be if Congress gets mad at them. Harvard and Yale, thanks to smart investing and bull markets, have posted tremendous gains in their endowments for several years. They have been slow to spend this money, probably because any use of endowment income for a recurring expense becomes a permanent commitment, one that would be tough to maintain if the endowment's investments decline in value for a few years in a row. The spectacular returns and resulting growth in endowment principal has attracted attention lately, some of it unwonted attention from politicians who are always looking to capture tax revenue without losing votes. Harvard and Yale have decided to fight preemptively by spending some of their endowment wealth on a populist cause, financial aid. As a result, the Fillet Mignon price is moving to a bigger discount for more people when they first enter the tuition grocery store. These two schools have the largest endowments of any colleges. Other colleges have also improved their returns on investment in recent years, but Harvard and Yale are leaders in performance as well as size of endowment. A few schools with elite reputations may expand aid to compete with Harvard and Yale for middle class scholars, but very few will do so as a political strategy.

So, how much should you save for your two year old? Thanks to expanding merit and need based aid, the frightening numbers on the ever increasing cost of a college education are overstated, but the answer is still: a lot, preferably in a 529 plan and/or education IRA.

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