When you think of assets, you probably think of your investments -- stocks, bonds, 401(k) account, and maybe your home. If you were going to calculate your net worth, you would add all of those up with your bank accounts and subtract any debt that you have. But is that really all you’re worth?
While those are common calculations, they miss something very important. They forget an asset so important that for most workers it is the most valuable of all. What is this mysterious, hidden asset that you don’t realize you possess? Your human capital.
What Is Human Capital?
Human capital is the present value of your future stream of earnings from your occupation. It is your earning potential. But it isn’t the pie-in-the-sky, maybe-someday kind of potential that a lot of mothers cling to while their adult children play video games in their basement. This is your earning potential based on concrete facts: your current career, education level, and the industry you work in.
When you enter the workforce, you usually don’t have a lot of financial assets. In fact, most Millennials enter the workforce with student debt, not brokerage accounts. Most financial professionals would say that you have a negative net worth in that situation. But, here at Accumulation Wealth Partners, we consider your total economic wealth to be more than just your financial capital, it also includes your human capital.
As the chart below shows, most people start out with a lot of human capital and hardly any financial capital. As you near retirement, your human capital diminishes and your financial capital should increase as you save diligently. Your total economic wealth is the combination of both your human capital and financial capital.
Source: Dimensional Fund Advisors
How Does Human Capital Fit Into A Portfolio?
So, if your human capital is the majority of your total economic wealth, how does that affect the other areas of your financial life? What difference, if any, does it make in your investment portfolio? You may think that human capital is such an intangible thing that it can be hard to compare and combine it with things like stocks and bonds.
Are You A Stock Or Bond?
To integrate your human capital and financial capital, it helps to think of your human capital in financial capital terms. Are you a stock or a bond? That is to say, based on your occupation and its inherent risk levels, what type of investment class does it most closely resemble?
A tenured university professor doesn’t have a lot of occupational risk and can expect a steady, predictable income stream throughout her working life. Her human capital is more like a bond, stable and dependable. A small business owner or entrepreneur is much more like equity stock. He can expect a lot more ups and downs with his income, but in the end, he has the potential to reap a much greater financial reward. The long-term payoff is worth the unpredictability and the uncertainty of the day-to-day for him.
Once you’ve established the type of asset class your human capital most closely resembles, you can include it in your overall portfolio to analyze the risk. The university professor might have room in her portfolio for more aggressive equity investing because her human capital is steady and predictable, while the entrepreneur might want to take fewer investment risks to balance his occupational risks.
Industry even plays a role in creating a balanced portfolio. It’s common advice that you shouldn’t have a lot of capital tied up in your own company’s stock for diversification’s sake. But you need to look beyond your company to your entire industry. A lot of risk is industry-specific, not company-specific.
For example, if a Qualcomm employee has a lot of investments in the tech sector, any downturn will have a negative effect on both his financial and human capital. He might think he is safe if he doesn’t invest in individual tech stocks or sector mutual funds, but he’s not. A lot of market cap weighted index funds and ETFs are overweighted to the tech sector. That’s something that needs to be accounted for.
Human Capital And The Financial Service Industry
Unfortunately, most of the financial service industry only recognizes financial capital. If you can’t charge a commission or fee based on it, it simply doesn’t exist in their minds. Wall Street can’t “manage” human capital the way they can financial capital, so they have no time for people who are only rich in human capital.
At Accumulation Wealth Partners, we see things differently. We know that your human capital is just as important as your financial capital, so you don’t need financial capital to work with us. We won’t make you wait until you have a bunch of money saved up to work with us. After all, we think that the sooner you work with us, the more money you’ll be able to save!
Human capital should not be overlooked as most do. We believe it is our duty to help clients estimate their human capital and plan around it so that the transition of it to financial capital and savings is optimized and more efficient. If you’re only rich in human capital, we’re here to help. Follow this link to schedule a free 15-minute introductory phone call or email firstname.lastname@example.org 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 email@example.com.