Your Most Valuable Possession? That Would Be Your "Human Capital"
- Your income-earning ability may be your most valuable asset.
- Education can be a great investment, because it could enhance your earning ability.
- If you don't have enough to retire, consider relying on your human capital-by working part-time.
You look like a million bucks. Suppose you were drawing up a list of your assets. Sure, you would consider including your house, stocks, bonds, mutual funds and savings account.
But if you are in your 40s or younger, the assets you have amassed likely pale next to the value of your "human capital," which is your ability to haul in a paycheck. Let's say your annual salary is $60,000. To appreciate how valuable this income is, think about how much you would have to invest in certificates of deposit to get back interest of $60,000 a year. The implication: Your human capital might be worth $1 million-and maybe much more.
All this raises some key questions. How can you make the most of your human capital, how should you protect it-and how does your paycheck fit into your bigger financial picture?
Giving and getting. Your income-earning ability will hinge on a host of factors, most likely including your work ethic, education, network of business contacts, employment experience, how rare your set of skills are and how creative you are in coming up with new products, new services or better ways of performing existing tasks.
This is typically what you have to offer, whether as an employee or as a business owner. But what do you get in return? It isn't just dollars and cents.
Your employer may provide valuable perks such as life insurance, medical insurance, disability insurance and retirement-plan contributions. There are also harder-to-measure benefits, such as job security, a pleasant office environment, the ability to work from home and having a position you find especially fulfilling.
Given that your job likely consumes a big chunk of each week, the quality of your work life is critically important. Indeed, there's a sense that the work world has become increasingly divided-with many folks at the mercy of the economy, while others are highly prized, enjoying healthy paychecks, exciting jobs and ample opportunities.
Capitalizing on yourself. How does all this fit with your larger financial life? Here are seven implications:
Source: Jonathan Clements, Director of Financial Guidance, Citi Personal Wealth Management.
- Education can be a great investment, because it could enhance your earning ability and widen your employment opportunities. What sort of payback can you expect from any extra years of education? According to the Economic Policy Institute, college graduates are not only less likely to be unemployed, but also they earn an average 75% more than workers with a high-school diploma.
- If you find it tough to make ends meet, maybe you should focus less on cutting spending-and instead think more about how you can boost your income. That might mean seeking a job at a rapidly growing company or relocating to a faster-growing part of the country. That might mean taking advantage of training courses at work or looking into the classes offered at the local community college. That might mean developing a strong network of contacts, by staying in touch with school friends and former colleagues and by regularly talking to headhunters. To look for a new job, check out sites such as www.careerbuilder.com and www.monster.com. Meanwhile, you might build your network of contacts using sites like www.linkedin.com and www.plaxo.com.
- Given the value of your earning ability, you need to protect it. If you have family that relies on your paycheck, you should probably have life insurance. Similarly, for both your sake and the sake of any financial dependents, you may need disability insurance in case you can't work because of an accident or serious illness.
- Think of saving for retirement as the gradual replacement of human capital with financial capital. When you enter the work force in your early 20s, you likely have very little savings, but your earning ability is hugely valuable. Over the next 40 years, your goal is to build a big enough nest egg, so you no longer need a paycheck and you can retire.
- This shift from human to financial capital also has investment implications. Your regular paycheck is similar to receiving income from a bond, a certificate of deposit or some other interest-paying investment. Early in your career, with four decades of paychecks ahead of you, this "bond" dominates your total wealth, which is why you should consider investing more heavily in stocks with your savings. But as you approach retirement and your last paycheck, you will want to buy more bonds in your portfolio, to replace your disappearing human capital, though you probably shouldn't abandon stocks entirely. You can also replace your paycheck with income from Social Security, immediate-fixed annuities and any pension you're entitled to. One caveat: Not everybody's paycheck is bond-like. If you run a small business or you work on commission, your income might fluctuate sharply from month to month-and thus you might want to be more conservative with your investment mix, to complement the uncertainty of your paycheck.
- We all favor investments we know well and which we're most comfortable with. But this can be dangerous. For instance, some employees invest in their own company's stock. But if the company gets into financial trouble, these employees may face a double whammy, potentially losing both their savings and their jobs. This highlights the need to take a broader view of diversification. If you work for a bank, you may want to steer clear of financial stocks, so you don't have both your paycheck and your portfolio riding on the success of the financial sector. Similarly, if you work in real estate, you probably shouldn't sink a hefty hunk of your wealth into rental properties.
- If you are approaching retirement and you don't have quite enough financial capital, consider relying partly on your human capital-by working part-time in retirement. As a rule of thumb, once you're retired, you can withdraw $4,000 or $5,000 a year from your portfolio for every $100,000 saved. In other words, if you can earn $15,000 a year working part-time in retirement, that's like having a nest egg that is maybe $300,000 larger.
The information provided here is solely for educational purposes. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.
The information provided is solely for informational purposes. It is not an offer to buy or sell any of the securities, insurance products, investments, or other products named.
Sourcing: Data on earnings of college vs. high school graduates reported in The Wall Street Journal, July 17, 2008.
Past performance is not a guarantee of future results. Diversification does not ensure against loss.
Bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk. In general, as prevailing interest rates rise, fixed income securities prices will fall. Bonds face credit risk if a decline in an issuer's credit rating, or creditworthiness, causes a bond's price to decline. High yield bonds are subject to additional risks such as increased risk of default and greater volatility because of the lower credit quality of the issues. Finally, bonds can be subject to prepayment risk. When interest rates fall, an issuer may choose to borrow money at a lower interest rate, while paying off its previously issued bonds. As a consequence, underlying bonds will lose the interest payments from the investment and will be forced to reinvest in a market where prevailing interest rates are lower than when the initial investment was made.
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