One of our favourite ways of looking at wealth is that it comes in two forms - financial capital and human capital. Generally, while investing, humans are more skewed towards financial wealth, often ignoring the value of human capital. But what is human capital?
Simply put, human capital is the present value of your projected earnings till you retire. It is your ability to earn till you can. When you’re at the beginning of your career, your financial assets would be negligible because of your low income and inability to save. However, at this point, the value of human capital is maximum because you’ve got a greater number of years in hand to put in.
However, as you age, the value of your financial capital will increase, and that of human capital will proportionately decline. Over the course of your career, you essentially convert your human capital into financial capital. Once you grow old, you will have exhausted your human capital and will rely on your financial capital for survival.
Modern human life can be divided into broad phases: income generation, wealth accumulation, and preservation/distribution. For those generating income and in their early stages of career, investments can typically be risky and long-term. Because even if the value of their financial portfolio erodes, they’ve got copious amounts of human capital to cover it up. However, near retirement, when the human capital is negligible, financial capital needs protection and safety in low-risk classes.
Nature of Human Capital
The other dimension to consider is the nature of your human capital. Are you a stock or are you a bond? Is your job risky? If your profession (and consequently income) is highly cyclical in nature, or uneven because of commissions, or is highly correlated to the stock markets, then you resemble a stock. However, if you’re a professor, or a doctor, or in a profession where your role draws you a steady income and growth, then you’re more like a bond.
Why is this important? If you’re in the early stages of your career, you might want to balance your overall portfolio. For a stock broker, the industry is characterised by high risk, and within that, a large part of the income is hinged on to bonuses and commissions. In this context, if everything earned was put into stocks, one market downturn is all that is required to dent the ability to earn on the job, and leave stock-related investments so severely damaged that they don’t provide any interim support.
On the other hand, if you’ve got a steady income source and large human capital left, it would make sense to invest in risky assets, and capture higher returns over the long term. Your financial investments can contribute to your portfolio in ways that your profession doesn’t.
Human Capital and Portfolios
Financial capital gets disproportionate amounts of attention and resources, whereas human capital is often overlooked. Irrespective of whether your life resembles a stock or a bond, your portfolio needs rational thoughts applied towards diversification.
While it’s common for us, at a young age, to excessively focus on building financial wealth to the extent that we ignore our ability to elevate the potential of human capital; it is also often that we don’t let our financial portfolios work for us – either as saviours or as boosters.
When looking at investments, it is important to come to terms with the fact that a portfolio is personal. It is meant to work for you. Finding investment opportunities that are attractive isn't wrong. However, keeping in mind how it impacts a portfolio is what needs to be assessed.
Personalisation is one of the pillars of our investment philosophy. We do recognise that one size fits all is a flawed approach. We strive to understand who our users are and offer portfolios that suit their needs.
Too much risk, and you're deemed to go through a turbulent time during high periods of volatility and downturns. Too less, and you're at the risk of not utilising the full potential of the money you have made.
Your money needs to be treated in ways that add value to your life; and balance out the level of human and financial capital you have.