Investing for a lifetime


We tend to regard wealth as financial assets, large houses, and nice cars accumulated through a life of hard work.  Yet that is to view wealth in narrow terms. On the very day we are born, we are wealthy in terms of our human capital: in other words, the value of all the potential earnings that we will generate over our working lives.

This potential should be reflected in how we invest during the 'accumulation' phase of investing, i.e. our working life. 

When we're young, we have a long time to go before needing the money we're investing. So the advice we receive is often that we should invest our excess earnings (those we don't need to pay the bills and enjoy life now) mainly in equities.  

A subtler approach, however, takes into account the attributes of each person’s human capital - or the nature of the job or career they have. For example, a university professor and a fin-tech entrepreneur have very different attributes when it comes to income stability and growth. A professor has a stable income, linked to inflation and job security, whereas the entrepreneur has little income stability, but a higher potential for growth (and loss). Viewed as an asset class, the professor’s human capital acts like a bond, the entrepreneur’s as an equity.

So, if they are both 40 years old and have the same level of financial capital, should they invest in the same way?  Intuitively, the answer is no.

"Human capital should be treated like any other asset class; it has its own risk and return properties and its own correlation with other financial asset classes"

Ibbotson, Milevsky, Chen and Zhu (2007)

Those with more bond-like human capital could well take on more risk, whilst those with more equity-like human capital should, perhaps, take on less risk with their financial capital. 

Ironically, it is also possible that those who choose steady, stable jobs may have lower tolerance to losses than the entrepreneur, and vice versa. You can see the risk in this scenario.  In the same way, two partners may also have different levels of risk in their human capital. Imagine a professor married to an entrepreneur; in human capital terms they are like a balanced portfolio between bonds and equities, and their investable portfolio of financial capital should reflect this.  


Source: Albion Strategic Consulting

Cash-flow modelling can help us understand the financial impact of changes to our human capital as we go through our working life and into retirement. Owning sufficient life cover to protect our outstanding human capital should be an important part of the discussion.

To read more about human and financial capital, download Acuity Volume 36: If I Were A Rich Man