Yes, financial capital such as stocks, bonds, and alternatives are important assets. But, the most important asset in your portfolio is probably you: your human capital.
Economists often define human capital simply as the net present value of lifetime earnings. A recent estimate pegged the total human capital in the United States at $700 trillion. Compare that to investment portfolios of $45 trillion. Actually though, human capital is much greater than $700 trillion. It’s the sum total of competencies, knowledge, social and personality attributes, including creativity that produce economic value. It is seen in many venues including the workplace, homemaking and volunteering.
We certainly have more control over our human capital than the financial markets. We can switch jobs, obtain graduate degrees, work more (or less), become an independent contractor, or start a business. In the long run, an entrepreneur, for example, may greatly increase their financial capital as a result of investing in themselves and their business at an early age, thereby increasing their income from and equity in the business for years to come.
Many financial advisers focus only on wealth, the financial capital portion of the assets, for financial independence (retirement) planning. They may neglect income, expenses and cash flow. As John Wasik in the WSJ put it recently, “Figuring human capital into a prudent financial plan requires attention to detail that most financial advisers may not be able to handle.”
At DWM, we focus on both human capital and financial capital. We believe that a person’s financial independence or well-being depends not only on wealth, but their income and consumption of goods and leisure over her entire lifetime. The planning starts with a discussion of the client’s goals, their wants, their needs, and their wishes. Human capital comes first and the portfolio management follows. Every part of the detailed process is important, including cash flow management, financial independence planning, tax planning, risk management planning, estate planning, and portfolio management.
Occupations can have a large impact on the investment strategy of a client. A tenured professor, for example, with an excellent job and a well-funded pension program, can likely take more risks. His job is almost like a stable bond investment and hence, he can withstand more risk with his financial capital. Jobs with uncertain futures or owners of start-up businesses might be characterized as risky stocks. Hence, those people should dial down the risk of their financial assets. Lastly, someone who has a great job in one industry should consider diversifying their investments away from that industry so as not to put all of their “eggs” (both human and financial capital) into one basket.
Please note that the chart above does not show human capital at zero at the theoretical time of retirement. The fact is that most Americans in their 60s, 70s, 80s and beyond still have a substantial amount of human capital. This capital might be used to produce income. A recent Gallup survey shows that the traditional notion of retiring at age 65 is disappearing. 37% of respondents said they plan to work past age 65 – a sharp increase from 14% in 1995. In addition, many are employing their human capital, without pay, to make the world a better place. For many of our DWM clients, it’s one of their long-term goals.
Yes, your financial capital is important, but don’t neglect the importance of your human capital. For most of your life, it is likely your most important asset. And, even when you reach financial independence, your human capital can still be a powerful asset for decades to come.
At DWM, we understand not only financial capital but also the importance of human capital. If you’d like to discuss it more, please give us a call.