Everyone knows what they have in their personal bank account right now (or at least you should). Most people have some general idea what they currently have in their 401(k) account as well. Maybe you even know approximately how much equity you have in your home. These are all inputs that add up to one’s “financial capital” or, more basically, what a person has made and saved over their life up until today. Now, while these figures are important and finding ways to best grow them is a key component of wealth management or financial planning, I find that younger, accumulator clients have often overlooked and unmanaged one particular asset on their household balance sheet: HUMAN CAPITAL.
One’s human capital is essentially the future earning power one has left in their career. We calculate it by discounting the sum of your future earnings (net present value of those earnings) back to a value today so that we can show it on your household balance sheet and compare it to the financial capital that you have already saved.
Why Do We Care About Future Earning Potential?
Future earning potential enables us to see patterns and better optimize saving strategies and investments for you TODAY, which will pay dividends later in life. For example, there is a “human capital curve” (see graph below) that illustrates how human capital diminishes over time and hopefully turns into financial capital the closer one gets to retirement. One can then take that financial capital and convert it into a retirement income stream that allows them to enjoy retirement without financial worries. This is the goal on most generic financial plans, but almost none take human capital into account and use it in the optimization phase of an “accumulation plan.” We continuously strive to produce better outcomes, specifically for our younger, accumulator clients. Calculating, accounting for, and using human capital as an input in the optimization phase of our financial planning process is one thing that differentiates us at Accumulation Wealth Partners. (Differentiates is a polite word for “makes us better” than the legacy firms.)
Source: Dimensional Fund Advisors
How Is Human Capital Used To Optimize My Financial Plan?
Sure, you may be working at a great job or your business is doing well, but have you considered what your income might look like a few years down the line? First and foremost, after raising kids and putting them through school and college, we will find ourselves in our mid to late 50s, and will this current job be enough financially? These are all questions we want to help you understand now rather than later.
Also, one huge aspect of financial planning and investing revolves around risk. Many legacy firms make you take an almost meaningless, often misguided and antiquated risk tolerance questionnaire when you sign up with them. Why do they do this? Not to help you “find your sweet spot between stocks and bonds” or “find an allocation that can help you sleep at night.” No, they do this to protect themselves, as a “compliance” tool to show in their records that you signed off on the allocation; and if it doesn’t work out, you can’t sue them. Well, we have never seen that help clients reach their goals, so we have long been advocates of “goal-based investing,” which essentially links an investment account (or part of an account) to a specific goal. It then allocates the assets in that account in a manner that best lines up with that goal’s time horizon and adjusts this accordingly over time as you approach that goal. The most often cited goal for most people is retirement, and this is where human capital can play a pivotal role. If we add one’s human capital to their financial capital that is directly related to their retirement goal, we get a much more holistic picture of one’s position in relation to that goal. Also, the human capital acts more like a bond, paying out income (your earnings) each year, and serves as the ballast to retirement goal. Your financial capital devoted to retirement (mainly your 401(k), IRAs, and Roth IRAs) can then be optimized and most likely invested more aggressively into stocks as those earnings off your human capital will help when markets dip and allow you to ride out bear markets.
The Bottom Line
By considering your human capital early in your financial life and using it to make adjustments to your goals-based investment portfolios, you are able to help yourself capture more of the equity risk premium (returns of the stock market) through behaviorally changing the way you look at your household balance sheet.
Here at Accumulation Wealth Partners, we believe it is our duty to help clients estimate their human capital and plan around it so that its transition into financial capital and savings is optimized and more efficient. Follow this link to schedule a free 15-minute introductory phone call or email email@example.com for more information on how to quantify your human capital and how it should fit into your overall investment approach.
Scott Melbrod is the founder and CEO of Accumulation Wealth Partners, an independent wealth management firm in San Diego, CA. Working with a wide array of clients, from families to young Millennials just starting their careers, his mission is to provide impactful and targeted financial advice at a transparent cost to people in their accumulation phase of their lives. With more than 15 years of industry experience, he uses his knowledge to develop for his clients a structured and tailored plan designed to guide them toward financial freedom. Learn more about Scott by connecting with him on LinkedIn or emailing him at firstname.lastname@example.org.