will be funded by their financial capital — the numerous assets that have been
accumulated in various types of accounts, that can either generate income
directly, or be systematically liquidated to free up necessary cash flows.
For younger clients, though, the reality is that their "human capital" — the
ability to generate earnings from their labor — is actually the greatest asset
on their balance sheet, and financial capital simply represents human capital
that was converted to income and saved rather than spent.
From this perspective, the reality is that for younger clients, financial
planners can bring significant value to the table by helping clients to enhance
and maximize not just their financial capital, but also their human capital.
Sometimes, it may even be better to invest in the client's career than a
tax-preferenced retirement account, and many clients unwittingly fail to
diversify between their financial and human capital.
Accordingly, in the future firms that are aiming to serve younger clientele
should consider adding "career asset management" services, and advising clients
on their career decisions, and not focus too heavily on "just" the financial
products clients need to purchase or the assets they have available to manage.
In fact, such services may be especially conducive to an ongoing retainer-style
financial planning engagement, and become a way for advisors to bring value to
the large number of underserved Gen X and Gen Y clients. And of course, clients
who are effective maximizing their human capital in the early years may even
become the clients with the most financial assets in the future, too!
Defining Human Capital:
The concept of "human capital" is relatively simple: as human beings, we have
the potential to labor, create products, and/or render services in exchange for
compensation (in the past for barter and trade, in today's modern economy for
money that can be used to fund various consumption needs). The more income we
can generate, and/or the longer we're willing to do the work, the greater the
economic value of our worker capabilities. Accordingly, the total value of our
"human capital" is simply the (net present) value of our future earnings
Ultimately, as we work and labor, we convert our human capital potential into
actual income and cash flow, which in turn we can choose to spend (consume now)
or save in the form of financial capital (to consume later). In fact, viewed
from this perspective, arguably then our primary source of wealth as human
beings is actually our human capital, and our financial assets simply represent
the portion of our human capital that we chose to save for future consumption
rather than spend at the time it was earned (supplemented, perhaps, by an
outside inheritance). In fact, we
could show a client's balance sheet as a combination of assets in the form of
financial and (lifetime) human capital, against which we have financial and
(lifetime) spending/consumption goals. If our lifetime assets
exceed our lifetime liabilities, the remainder is positive and we will leave a
financial legacy behind; if the remainder is negative, we are living beyond our
means and need to either decrease our liabilities (spending) or increase our
assets (earn more or work longer to expand our human capital).
The moment of retirement represents the point where human capital goes to $0,
and our remaining consumption needs for life must be dependent upon financial
capital alone. Conversely, in the earlier years, total wealth may be dominated
by potential human capital, as little has yet been earned and saved in the form
of financial capital. Accordingly, we also purchase disability insurance to
protect against the risk that the value of our human capital — especially in
those early years where it represents the dominant portion of our wealth — might
unexpectedly experience a precipitous decline as a result of an accident or
significant change in health.
Planning For Human Versus Financial Capital:
The reason why this distinction between financial and human capital matters
is that just as we engage in financial planning to help clients maximize their
use of financial capital, so too can we engage in financial planning strategies
to maximize their human capital. In fact, for younger clients — where the size
of human capital may dwarf the value of their financial capital — effective
human capital planning may actually represent the greater opportunity to add
For instance, over a multi-decade working career, helping clients to
negotiate a raise, or earning some additional income from consulting or self
employment, can have a dramatic financial impact. Similarly, when human capital
is viewed as an asset that can be invested in and enhanced, it even raises the
question of whether young people should focus on saving more in the early years,
or instead trying to reinvest into their careers with job skills that can secure a future
raise may be an even better deal than contributing to a Roth
IRA. Overall, the reality is that for many clients, helping them
negotiate a 1% raise will have drastically more financial impact than trying to
generate another 1% of returns.
In addition, it's notable that sometimes planning lies at the intersection of
financial and human capital. For instance, from the perspective of total
balance sheet diversification, arguably those with more stable human capital
can afford to take more portfolio risks, while those with volatile human
capital should invest far more conservatively. Thus, for instance, a government
worker or a tenured professor might have an aggressive portfolio, while a
salesperson or an athlete might be invested far more conservatively... leaving
both with comparable volatility on their total balance sheet.
Similarly, when an individual's human capital is already tied to their company
and industry, it becomes even clearer why their financial capital shouldn't be
concentrated there as well.
And of course, in practice many clients will make decisions about one part of
their balance sheet to help the other. For instance, choosing to work longer
and adding more years of income to the picture can help to shore up a shortfall
of financial capital (as can choosing to spend less and reducing the
'liability' of cumulative future consumption).
Financial Planning Services To Enhance Human Capital:
So how does this fit into the framework of services that a financial planning
firm provides to its clients?
The first is to simply recognize the intersection of decisions about
financial and human capital, from recognizing that sometimes investing in the
human capital is a better decision than saving financial capital, to the fact
that sometimes the risks of one may need to be balanced against (or diversified
away from) the risks of the other.
Certainly, for advisory firms that concentrate on retirees and near-retirees,
the benefits of a focus on human capital will be limited; quite literally, the
clients will have nearly depleted their human capital at that point, and their
financial capital will be the larger of the two, and the one justifiably most
deserving of attention. But for younger clients, particularly those in the Gen X
and Y demographics, human capital may represent a far greater opportunity and
value-add, and a way for advisors to provide value for those who don't have the
financial assets to purchase traditional financial products or engage on an
assets-under-management basis. In fact, human capital advice services — and the
ongoing nature of the opportunity as the client's career unfolds over time — may
be a particularly effective service to wrap into an
ongoing monthly retainer style business model for serving the younger
The bottom line, though, is simply this: for a huge number of clients,
especially amongst those who are not already retired, human capital is not only
an asset that can be managed, advised upon, and enhanced by good financial
planning, but may actually be the largest asset on the client's balance sheet.
Isn't it time to give that asset more financial planning attention? Or are you
one of the few who are already providing value to clients in this area?
This post originally appeared at Nerd's Eye View.
Michael Kitces is a Partner and the Director of Research for Pinnacle Advisory
Group , and publisher of the financial planning industry blog Nerd’s Eye View . You can follow him on Twitter at @MichaelKitces , or connect with him on Google+ . Copyright
2013. Follow Nerd's Eye View on Twitter.
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