The Biggest Financial Asset in Your Portfolio Is You
By JOHN
F. WASIK | New York Times – Tue 12 Feb, 2013
WHAT is probably your most
important asset? Stocks? Bonds? Real estate? Collectibles? None of the above.
It is human capital.
Although most of the focus in
wealth planning is on financial assets, human capital is the one thing you can
bring to the table that can have the most impact on your future. Yet few
advisers stop to measure it fully and discuss its impact on your prosperity.
You have a surprising degree of
control over your human capital, unlike the financial markets. You can switch
jobs, obtain graduate degrees or simply work more as an independent contractor
or partner in a professional firm. In contrast, you have no control over what
stocks, bonds, commodities, real estate and other assets return every year. So consider
human capital a measurable return on investment — in yourself.
The stodgy economist’s definition
of human capital is the net present value of lifetime earnings. This is what
you will earn based on the skills, experience and talent you contribute to the
labor market. For some, this is a fixed quantity, but in a dynamic world where
people are increasingly shifting careers, working longer or pursuing “encore”
careers, human capital is a moving target.
Yet estimating human capital is a
bit like trying to guess your life expectancy. Life throws us a lot of curves
and income gauges look easy to calculate as they emerge from a software
program. Nevertheless, you need to do some projections of lifetime earnings,
and potential changes in your income stream, to make a realistic, flexible and
holistic financial plan.
Zvi Bodie, a professor of finance
at Boston University and co-author of “Risk Less and Prosper” (Wiley, 2012),
says it is essential to know your human capital factor because it ties into how
much risk you can take in your financial portfolio. Mr. Bodie has been a
pioneer in applying economic life-cycle theory to human capital decisions.
Some, with a fairly secure income
over their career — like college professors — may take more risk in their
portfolios, while others whose income is linked to cyclical industries may not.
You can characterize your human capital like a stable bond or an insecure
stock. This is one of the first steps in linking your human capital to how much
risk you may take in your portfolio.
“I see myself, for example, as a
convertible bond,” Professor Bodie said. “I’m protected by tenure at a solid
university and have the potential to do extra things for income. I have a lot
more capacity to take risk in my portfolio than I choose to use. I’m
risk-averse, don’t like to gamble and don’t get a kick out of winning. I hate
to lose.”
Noting that “human capital is not
a major asset for only a tiny fraction of the population,” Professor Bodie said
that lifetime earnings and portfolio management should be reframed as a way of
insuring a standard of living and not a focus on obtaining the highest returns.
Figuring human capital into a
prudent financial plan requires an attention to detail that most financial
advisers may not be able to handle. Because most advisers are focused on
managing money or picking investments, they may not be able to do the right
calculations that are flexible enough to accommodate changes in income.
Paula Hogan, a fee-only certified
financial planner based in Milwaukee, has been employing human capital and the
life-cycle theory that underpins it into her business model for years. Like
most planners, she carefully examines cash flow, expenses, income and her
client’s portfolio.
“A key insight of life-cycle
theory,” Ms. Hogan said, “is that the consideration of human capital comes
first and then portfolio management comes after that: financial capital is
tailored to the human capital, not vice versa.”
Ms. Hogan also steps into the
realm of “life” planning that merges human capital with various goals and
changes in a person’s journey. This raises a set of questions that go beyond
numbers.
“What do you care about?” Ms.
Hogan said she asks clients. “Do you have a vision of where you want to be?” If
they want to change, the questions become more focused on transition. “How can
we make a bridge? What about health insurance? Will you need a new family
budget? Do you have family reserves (savings)? Is your spouse on board?”
Sometimes the transitions are
modest, as for an executive at the top of his profession whom she counseled. He
wanted to “not go at full tilt” and spend more time doing other things. Other,
more radical moves, like a career change, will require more support. Ms. Hogan
works with career coaches and counselors like Jane Schroeder of Brookfield,
Wis., to manage the vocational piece.
As a master career counselor and
board-certified coach with a background in educational psychology, Ms.
Schroeder applies standard assessment tools like the Myers-Briggs personality
test and talks with clients on future direction. She delves into their core
strengths, competencies, emotional intelligence and “brainstorms on
possibilities.”
“What allows you to engage your
human capital at the highest level?” she asks clients. “When were you at your
best? What was happening? What was energizing?”
By re-engaging clients with the
force that drives their ability to create, manage or earn money in a fulfilling
way, Ms. Schroeder eases the transition that some need to make.
It is one thing to know if you
need to make a change, but is that possible, given your financial situation?
Will you have enough cash reserves to see you through a transition? Will a
spouse or partner support your household while you make some changes or
re-educate yourself?
Before you even make the decision
to redeploy your human capital, you will need to run some numbers to see if it
is possible. Online planning programs like ES Planner (esplanner.com) can give you some general ideas
on what is possible given changing income and cash flow.
While these questions may be
difficult at first, they may help you forge a satisfying new path. But you will
need to take your time and do some detailed planning that may involve a
paradigm change.
Your personal capital reserve and
future earnings should drive your ability to make a change and not your
portfolio return. That is a big leap for most, but a rewarding one if you are
able to navigate it.
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SABH: Save And Be Happy!
Think
+ve, Be +ve
Ajit
Vidyadharan
Certified Wealth Manager / Financial
Advisor
Certified Trainer, Certified Leadership & Performance Coach
Sabhav Wealth Management Services
+919664966416
