Invest in You!

Sep 26, 2012 by

Some commenters on my “Why I’m Wary of Stocks” post were skeptical that significant opportunities besides stocks exist that can support a comfortable retirement and outpace inflation with less risk. Among the constellation of alternative investments I suggested was investing in education or training to boost income over your “career years.”

Education and Training Are Investments?

Absolutely! I suggest you look at furthering your education and taking training in an area new to you or to complement or advance what you already know the same way a business looks at making an investment. That means you ask yourself these questions:

  1. What’s the projected rate of return on the investment?
  2. What’s the risk, or the likelihood I’ll achieve the investment’s projected rate of return?

How to Analyze an Investment in You

I’m going to leave out some implicit assumptions and nuance that would understandably cause many of you to go cross-eyed and skip directly to the end of this post, but trust me: This is the sort of investment analysis MBA-types learn. I’ve used this approach myself in analyzing innumerable prospective capital investments (plant & equipment) for companies where I’ve worked.

We’re going to project the Internal Rate of Return—or IRR—for a hypothetical working lifetime of simple costs and benefits related to periodically investing in education and training. The IRR is one of several classic methods of evaluating and ranking (compared to alternatives) potential investments.

Imagine this: You’ve got a 40-year career. Every five years, beginning with year zero (the start of your career), you invest $7,500 in education or training. The benefit of your investment is that your income is $3,000 per year more than it would be otherwise. In other words, it’s an incremental $3,000 annual benefit that you would not receive if not for the periodic education/training investment. Here’s a picture to help you quickly understand this investment’s annual cash flow.

Annual net cash flow from investing in education or training

In words: In Career Year 0, the investment’s cash flow is -$7,500—the cost of the additional education or training. Then in Career Year 1 you earn an additional $3,000 (only $250 per month—a realistic expectation, in my view) because you’ve made yourself a more valuable employee. In Career Year 5 you again invest $7,500 in more education or training. You’re still earning the extra $3,000, so your cash flow in that year is -$4,500 ($3,000 extra income less $7,500 education/training cost).

Since our world changes rapidly and there’s always more to learn, I assume the benefit of the investment wears off over time. So the incremental $7,500 investments in education or training every 5 years just maintain the annual income benefit at $3,000. You’ve got to stay current, right?

Sound reasonable, though of course simplified?

Your Investment Return

As measured by the Internal Rate of Return and calculated by Excel’s IRR function, your return on the career-long investment in education and training pictured above is:

“Invest in You” IRR = 28.6%

 

What About Risk?

We’ve projected the IRR on this investment. Now how risky is it? That’s always a tough question no matter the investment. But, unlike stocks and many other investments, you have considerable ability to control the risk of an investment in education or training. For example:

  • Before spending money on specific education or training, you can talk to your employer, other employers, and colleagues in your network to learn more about the likelihood of the investment actually boosting your income and by how much. (Some employers help pay for certain training, which would make the IRR skyrocket.)
  • In doing your own analysis, you can be quite conservative in estimating the future income benefit of an education or training investment. And to improve your comfort level, you can do what’s called “sensitivity analysis,” asking yourself this question: What’s the least income benefit I might earn that would still make this investment worthwhile to me? I played around with my example above to see how low the annual income benefit could be before the IRR would fall below 10%. As long as the additional income benefit stays above $2,000 per year, I’ll earn more than 10% on my education/training investment. Not bad. You can decide the minimum IRR you want on an education or training investment, and then judge how likely it is the income benefit will be enough to generate at least that IRR.
  • You can do your own research and talk to your network to learn what specific education or training is most likely to provide you, given your unique background and experience, the biggest “bang for the buck.”

Yes, I’ve Taken Liberties

Let me anticipate some of the holes others may poke in this presentation.

  • The cumulative net cash flow for my hypothetical investment is only $60,000, a tidy sum but hardly a retirement nest egg. True enough: In my scenario, you’d be investing a total of $60,000 in education or training and gaining an additional $120,000 in income, over 40 years. First, this is just one example. You might invest $50,000 one time to earn an additional $750,000 over a 40-year career. Second, understand please, I’m not proposing this option alone as a substitute for investing in stocks. I’m suggesting that a prudent investment of $60,000 in you instead of in stocks is very likely to provide a superior return at less risk, contributing meaningfully to a nest egg. (You’re supposed to save, not consume, that extra $120,000 in income!) And I contend there are many other investments you can make that provide good returns at less risk than stocks, if only you’ll turn off CNBC and other mainstream financial establishment sources long enough to clear your mind of the Wall Street marketing chatter and open it to creative options!
  • Yes, I’ve ignored taxes. My IRR is pre-tax, since I didn’t take income and payroll tax out of the $3,000 annual benefit. First, often times (like now, for instance) the Federal government offers tax credits to help offset expenditures on education or training. Such tax credits might slash the $7,500 investment cost, which is also pre-tax. Second, I can’t predict the next 40 years of tax rates and tax credits, so I suggest doing the analysis pre-tax makes more sense anyway.
  • Yes, I’ve ignored inflation. But I’ve ignored it both in the cost of the additional education and training and in the annual income benefit. And I can’t predict 40 years’ worth of inflation either; trying would only pointlessly muddy the analysis, in my opinion.
  • I’ve failed to explain some of the assumptions implicit in IRR analysis. Guilty, as charged. If some of you finance types want to discuss offline whether these assumptions matter to the overall point I’m trying to make, please shoot me an email.

Wall Street or You?

Don’t get bogged down in the minutiae of IRR analysis. Rather, please bear in mind the Big Message I hope this article conveys, which is:

Investing in You is Just One of Many Very Viable Alternatives to the Wall Street Marketing Machine’s Drumbeat That You Must Buy Stocks or Retire on a Cat Food Diet!

I have not and am not today suggesting you avoid stocks entirely. As you know, we own stocks, but have invested a far lower fraction of our financial assets in them than virtually all “experts” would recommend. I’m merely suggesting that, the next time you have a chunk of money to invest, consider: With respect to risk and return, are you likely to do better investing in you or buying stocks? Further, isn’t diversification, rather than putting most or all of your nest eggs in the Wall Street basket, a desirable goal?

What Do You Think?

Have you invested in training or education to improve your income? Is it paying off?

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