Monday, January 23, 2012

Saving Up for College Tuition and Hedging, Part 1

One of the biggest expenses for many American families is college tuition. In fact, it is a component of the Consumer Price Index (CPI), though not a very big component. The other overwhelming expenses are transportation (typically cars) and housing. For transportation and housing costs, you can at least partially hedge against further price increases (however imperfectly) by investing in appropriate securities (crude or RBOB futures and Case-Schiller housing futures). According to the December 2011 CPI report, tuition has increased by almost 7-fold since 1984 (the baseline of the CPI). For comparison, tuition increases have dwarfed even growth in hospital services expenses (only 6.5x). The only component of the CPI that grew more was tobacco (8.4x). Thus, not only is tuition a big expense, it is also one of the fastest growing. According to the Bureau of Labor Statistics (BLS)'s analysis, the college tuition inflation rate averages about 6.7% annually for the past 10 years (with a low of 4% and a high of 9.8%), even amidst recession. Recession exacerbated the increases as governments cut funding. Now what kind of investment can give an 8% annual return even in the midst of a massive downturn? A tax-sheltered education savings account such as a Coverdell or 529 Plan helps, but even then a steady 8% pre-tax return from index or mutual fund investing is quite challenging. MyMoneyBlog puts everything in perspective, showing that tuition increases dwarf that of the housing bubble.

In this series of posts, I will be looking into the cause of tuition inflation and the different possibilities for dealing with the phenomenon in investment terms.

The College Board and BLS both collect tuition inflation data. The BLS's numbers are somewhat higher than that of the College Board, but both show that with the exception of stagflation during the 1970s, tuition inflation has exceeded inflation rates by a good margin. FinAid has compiled some of this data. It is also known that academic salaries especially at the higher rungs of seniority can be predicted by tuitions and tuition growth rates at the institutions of question.

There are certainly for-profit education stocks out there such as Apollo Group (APOL), Corinthian Colleges (COCO), DeVry (DV), Strayer Education (STRA), ITT Educational Services (ESI), and Career Education Corporation (CECO). These companies are highly sensitive to federal policy on student loans. At one point, they were the darlings of certain hedge fund portfolios (especially Blum Capital Partners). It is not obvious that the performance of such companies correlates with the tuition growth in 4-year colleges and universities. Moreover, tuition rises regardless of how well educational institutions are doing. Oftentimes, they rise the most when public support is cut, which normally would be a net negative for a business. So the question remains, how can a parent or guardian hedge against the rising costs of education?

See the second post.


  1. At the federal level inflation metrics have been revised multiple times over the last few decades, the most amusing example being the switch from using the arithmetic average to the geometric average, in order to slow the COLA increases in SS payments. tries to give a more accurate indication of the actual rate of inflation.

    Hedging against inflation in college fees is probably not possible as there is no safe investment that consistently grows as quickly as tuition costs.

  2. Thanks for the insights. Yes, as with many government figures, they are "man-made" as one government official in China puts it (referring to their own GDP and other economic stats). As for hedging, indeed, college fees growth does not seem to correlate very well with many of the financial assets out there. I certainly agree it would be difficult to hedge precisely using low risk or "risk-free" assets. Some periodically pull out claims such as an ounce of gold buys so much bread 40 years ago and it still buys the same now. I doubt that the same can be argued for college tuition. Still, this is an important expense for which many families potentially start saving long before it is incurred, so I remain open to the idea that some mixes of assets are better than others for this purpose. A number of schools are already offering prepaid tuition programs, which if hedging is really that difficult, would be a huge bargain. This makes me wonder how those colleges offering the program plan to fund it.

  3. Also, despite the difficulty, the financial industry is always coming up with new products, for better or for worse. Please check out my follow-up post tomorrow for some of the stuff they are selling. Whatever the merit of the products, it begs the question: how did they construct it and how are they hedging?


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