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Many people 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, or in other words, the present value of all the future earnings that we will generate over our working lives.  This needs to be reflected in how we invest during the accumulation phase of investing as a means to achieiving our own financial plan.

As younger people have a long time to go before they will need the money, the advice they receive is often that excess earnings should be invested predominantly in equities.  A subtler approach takes into account the attributes of each person’s human capital, which ranges from bond-like to equity-like in nature.  Take for example a university professor and a fin-tech entrepreneur; the former has stable income, linked to inflation and job security; the latter has little income stability and, most likely, a high correlation to the equity markets. 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)[1]

Human Capital - Financial Capital graph.png

Source: Albion Strategic Consulting

Those with more bond-like human capital could well take on more risk and 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.  One can see the risk of this scenario.  Additionally, two partners may also have different levels of risk in their human capital. Imagine a professor married to an entrepreneur; together they form a balanced portfolio between bonds and equities and their investable portfolio of financial capital should reflect this. 

Figure 1: How human capital attributes influence asset allocation

Lower equity content in portfolio

Higher equity content in portfolio

Low job and earnings stability

High job and earnings stability

Low earning flexibility

High earning flexibility

High correlation of earnings to equities

Low correlation of earnings to equities

Low earning capability

High earning capability (replenish losses quickly)

Source: Albion Strategic Consulting

Cash-flow modelling can help those in the accumulation phase of investing to understand the financial impact of changes to their human capital.  Owning sufficient life cover to protect the outstanding human capital should be an important part of the discussion.  It is difficult to see how a stockbroker or investment manager can structure a portfolio sensibly, particularly where the investor still has substantial human capital, without the insight into, and modelling of, the client’s total asset picture.  No financial portfolio is an island.


Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.


[1]      Ibbotson, Milevsky, Chen and Zhu (2007), Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance, Research Foundation of CFA Institute publication.

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