I recently contributed to my daughter's 529 plan; this was an unexpected move since my son has an Educational Savings Account rather than a 529 plan.
Rob and I initially chose an ESA for Kenny since the 529 plan for North Carolina seemed confusing, and ESA savings can be used for primary and secondary schooling as well as post-secondary education. After further research, I learned that I can open up a 529 with any state (which led me to judge the federal government for creating stupid tax codes), and that I can change the designated beneficiary on a 529 plan should the need arise. Thus, if either one of my kids goes to college, or if any of my future grandkids, or my nephews, or I pursue further education, we can use the money.
At the end of the day, I'm saying that saving in a 529 plan seems lower risk now that I understand it than it did previously. However, choosing to invest in a 529 plan led me to ask an important question- do I really want to save for post-secondary education for my kids?
My answer may surprise you; it definitely surprised me. I don't want to save for post-secondary education because I don't want my kids to go to college, but I'm being peer-pressured into it. Other kids will go to college, so I want my kids to go to college too.
Am I confusing you? Let me break it down using my favorite economic framework- Game Theory.
What are the choices that future young adults face?
At a high level, a 17 or 18 year old faces two "legitimate" decisions- the decision to pursue further education or the decision to start working for someone else. The option to become an entrepreneur is in fact a legitimate choice, but I will disregard that right now, and come back to it in my next post on specialization and entrepreneurship.
If young people in fact face just two options, then they need to understand the most likely outcomes of each of their decisions, but they need to understand their outcomes relative to other people. Why? Because other people will become employees, and the competitive wage market means that other people's choices matter too.
Below you can see the decision set that everybody faces.
The idea that somebody else going to college matters only in the fact that you and said other people will compete for the same jobs.
Now, in this scenario, I'm going to say that a college degree is valuable mainly because of a credentialing effect. This is to say that the education you receive may not be intrinsically valuable in your career, but holding a degree proves to employers that you can think, and that you can push through hard things. It's a signal that you may be a good employee. In my next post on specialization and entrepreneurship, I'll defend this position.
Supply and Demand for College Grads
If college is a credentialing effect then a college degree acts as a barrier to entry for certain potential employees. If you don't have a degree, then certain employers won't "pick" you as an employee meaning fewer employers want you, and your wages will be lower. This accords with the basic laws of supply and demand, pictured below.
In the scenario that I've defined. Non-college grads have permanently lower wages because the demand for less educated employees is lower. This is because demand for college graduates is permanently higher than demand for non college graduates.
Now, if I choose to go to college, and few other people go to college, I would expect my wages to surpass those of other employees. After all, I'm in greater demand.
If I fail to choose college, and everyone else goes to college, then I would expect my wages to be much lower than everyone else's wages.
If I choose college, and everyone else chooses college, I'm just as well off as everyone else.
If I choose work, and everyone else chooses work, in all likelihood, everyone is better off. Employers train us at their expense, college is no longer a barrier to entry, so our wages are just as high as if everyone goes to college.
Thus if college only acts as a credentialing effect, everyone is better off if nobody goes to college. See the diagram below.
Why everyone chooses college if nobody is better off
Even though everyone is better off if nobody chooses college, everybody will pick college. Why? Because each individual makes their college decision without coordinating with everybody else.
No matter what everybody else chooses, I'm better off choosing college. If I go to college and everyone else starts working, then I earn $70K, and everyone else earns $30K. If I fail to go to college when everyone else attends college, then I earn $30K while everyone else earns $70K. Thus, no matter what you do, it's always in my best interest to go to college. Except that it's not. The absolute best scenario is if none of us goes to college.
This is called Nash Equilibrium. Where we stay at a suboptimal equilibrium because it's in everybody's individual best interest to choose college, even though collectively we're all worse off.
In a game theory situation, the only way for everyone to "choose correctly" is to coordinate choices (usually by playing over and over again until somebody chooses correctly). The other way to create a better outcome is to change the outcomes that an individual faces. For example, if a person doesn't face as high of penalties for not choosing college, they may opt out, and everyone else might to.
Additionally, if college works as something besides a "signal" then the "rules" of the game change, and everyone makes better decisions.
Rigging the game for my kids
As a parent, I honestly want to rig the game in favor of my kids. The easiest way to do this is to save money for their college education. That way, if they choose to attend college, they will get as high of an income as everyone else without shouldering the cost.
However, I think that a multi-dimmensional method for thinking of college is actually a superior way to alter my kid's outcomes in their favor. That's what I'll discuss in my next post about specialization and entrepreneurship.
I'm a wife, a mom, an employee, and a personal finance nerd who is devoted to spreadsheeting my way through life.