Let’s All Work to Grow Human Capital!

Your biggest financial asset may be your human capital.  Yes, perhaps even more important than your investment portfolio, house, real estate and other assets.  Simply put, human capital refers to the abilities and qualities of people that make them productive.  There are many factors that contribute to human capital.  Knowledge is the most important, but discipline, punctuality, willingness to work hard, personal values and the state of one’s health are among the other factors.

Generally, younger people will have more human capital than financial capital.  In an economic sense, their human capital is the net present value of their lifetime earnings.  In a larger sense, human capital is our ability to add value to others and improve their lives and, by doing so, improve our own.  Decisions young people make early on regarding their education, their careers, their job choices, life partner choice, etc. will all have huge impacts on their eventual financial capital and human capital. Key questions they should answer include “What is your passion?” “When are you at your best?” and “What allows you to engage your human capital at the highest level?”

Historically, the cross-over point where financial capital starts to exceed human capital occurs when one is in their 50s.  However, with people living longer or pursuing “encore” careers, human capital may remain a significant personal asset for octogenarians and beyond.  A perfect example is 86 year old Warren Buffet who is committed to growing human capital:  “Investing in yourself is the best thing you can do.  Anything that improves your own talents cannot be taxed or taken away from you.”  Regardless of your age, human capital is like a garden, you need to continually give it your time and effort in order for it to grow.

For decades after WWII, the G.I. bill and the American economy pushed workers to build skills and maximize their economic potential.  This was arguably the greatest period of shared prosperity in the history of capitalism.  Last week’s Economist featured an article about University of Chicago Nobel Prize winner Gary Becker’s concept of human capital. Dr. Becker found that 25% of the rise in per-person incomes from 1929 to 1982 in the U.S. was because of increases in schooling.  Other components included on-the-job training and better health.  Dr. Becker was fond of pointing to Asian economics, such as South Korea and Taiwan, with few natural resources, who have invested in human capital by building up their education systems.  There is no debate that well-educated populations have greater incomes and broader social gains. There is a debate over whether the government should supply the education or students should bear the cost; yet both will receive the rewards.

Dr. Becker also wrote about “good inequality” and “bad inequality.”  Higher earnings for doctors, scientists and computer programmers, for example, help motivate students to push harder and achieve top paying jobs.  On the other hand, Dr. Becker wrote, when inequality becomes too extreme, the schooling and even the health of children from poor families suffers, with parents unable to adequately provide for them.  Inequality of this sort “depresses human capital, leaving society worse off.”

Certainly, many, if not most, of our DWM blog readers are committed to increasing and using their human capital to benefit themselves and others.  But, there are many Americans who do not or cannot.  Some are in occupations that have been hit hard by technological changes, others are in declining industries, others have limited education, and others have little opportunity.  As a result, there are lots of unhappy people due to this huge current gap between full human capital and employed human capital.  Can you imagine our country where the vast majority of our 323 million people were increasing their human capital and using it to benefit themselves and society?  Can you imagine an annual economic growth rate of GDP of 5-10%, like it was in the 60s and 70s, compared to the 2% it is currently?  Can you imagine hundreds of millions of Americans happy with their shared prosperity and with optimism for the future?

Let’s make growing human capital a lifetime commitment. And, let’s also commit to using our human capital to help others grow theirs.  It’s up to each of us. Mahatma Gandhi put it so well: “You must be the change you wish to see in the world.”

Your Biggest Asset: Your Human Capital

(click for full size image)
(click for full size image)

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.