There’s a great new song by the Young Giants called Amerika. It expresses the cynicism a lot of people have about the American Dream. At one point the lyrics say, “It’s a rich kid’s game and it’ll go up with a throw." I can’t say if the game will go up with a throw (or even what that means), but the American Dream is definitely a rich kid’s game.
Last year, Zillow analyzed Federal Reserve data and found that 28% of people 23-34 had their education partially or completely funded by their parents. An even luckier 3% had both their house down payment and college education funded by their parents. Those people will be able to build wealth far quicker than those who needed to finance school with loans.
When this data was released, many bloggers and journalist predicted this would create massive wealth inequality between those with student loans and those without, with the lucky 3% who didn’t need to make a down payment benefitting the most.
Is this true? Does financial assistance for tuition and home purchases make that big of a difference with building wealth?
I decided to look into this because I wanted a dollar amount on the short-term and long-term impact these differences make. It turns out it's difficult to predict. People don't live the same lives and their saving habits, work ethic, and talent are as big of factors as student debt and family background are.
So to make it easier to compare, I decided to show the difference between three people with three identical incomes and lifestyles:
Jane, who has $40k in student loans and no help with a down payment
Tom, who doesn’t have student loans and no help with a down payment
Buck, who doesn’t have student loans and received help with his down payment
In this scenario, all three people earn a healthy midwest salary of $40,000 a year. After taxes and 401k contributions, all three would earn approximately $2,499 a month.
All three want to own a home valued at $132,000, which is the median home price in Missouri. Buck's parents gave him enough to put 20% down, while Jane and Tom will only put the minimum 3.5% down to catch up.
Jane spends half of her money on rent, student loans, and saving money for a down payment. She can only save $281 a month, while her student loans cost $411 a month and rent cost $658. It would take her 16 months to save enough for the minimum down payment on a home (3.5%) the same value as Buck’s.
Tom's budget is not as bad. He can actually save more money than he spends on rent every month. He can save $691 a month. It would take him a mere 6 months to save enough for the minimum down payment on a home valued the same as Buck’s.
Buck has it made. He actually saves a little less cash a month than Tom, but he can immediately spend that money on a vacation, a new Playstation 4, or invest it to make more money in the stock market. That money isn’t obligated to go anywhere.
You might be thinking that this isn’t that big of a deal. Jane will pay off her loans in ten years and still be able to buy a house in a shorter time. You’re right. If they were only concerned with spending their money on whatever, it is only a short-term difference.
People who read my ebook or my blog know that I view things differently. The economics major in me thinks about opportunity cost, or what potential investment returns I lose out when comparing future budgets.
What if Jane, Tom, and Buck were ambitious and prudent financial savers? Let’s say they wanted to invest their extra money in the stock market. What would the difference be?
Here’s a chart comparing the difference at a 5% return of investment:
Here’s a chart comparing the difference at a 8% return on investment:
Tom and Buck leave Jane in the dust. For the first ten years, they're able to take advantage of early compound interest while Jane is unable to save and build wealth outside her home or 401k. In fact, her mortgage and mortgage insurance prevents any further outside savings until she pays off her loans 10 years later.
At 5% ROI, Tom would end up with $300k more than Jane and Buck has $380k more than Jane (and only $80k more than Tom).
At 8% ROI (closer to the S&P 500 historical average), Tom has $700k more than Jane and Buck has a whopping million dollars more than Jane.
It is safe to say that financial assistance with college tuition has a bigger impact than financial assistance with a home downpayment. Higher tuition will undoubtedly lead to more wealth inequality, both in the form of student debt and those who choose not to go at all.
If you need student loans to go to college, don’t let this discourage you. The scenario I ran is comparing the difference in outcomes between college graduates, but doesn’t include the wealth produced by buying a home or your 401k. When you include the value of the home, 401k, and their growth, Jane would be a millionaire. She would still be very well off compared to most Americans.
Also keep in mind that I’m comparing three people with the exact same income and budgets. I don’t include the impact of raises, career choices, healthcare, or spending habits. What if Buck decided to quit working and become a professional crocheter? What if Jane went to school for engineering while Tom went to school for restaurant management? What if Tom was a lazy d-bag who got fired after a few weeks on the job?