Building Wealth: Your Human Capital vs. Financial Capital

I began my career as a young sales manager in the hospitality industry and earned an annual salary of $26,000. Little did I know at the time that my human capital – as in, the present value of my expected future income throughout my working lifetime – would be worth nearly $3,000,000!

I recently did some back-of-the-napkin calculations and was surprised to learn that I had already earned $1.4 million dollars over an 18-year career. I found that incredible, given that I had never earned a six-figure salary and, my wages had been stagnant for several years.

Projecting my income forward using a modest 3% annual growth rate revealed the potential to earn another ~$1.6 million by the time I turn 55.

Human Capital vs. Financial Capital

Put in different terms, however, and you can see that my human capital is shrinking each year. That’s because the value of my human capital peaked the day I started my career (back in 2003) with my entire lifetime of earnings ahead of me. Since then I’ve steadily used up my earning power and the value of my human capital has gradually declined.

The idea of eroding capital doesn’t sit well with me, but that’s where the second form of wealth building – your financial capital – comes into play. See, I’ve been a diligent saver for most of my career, which means converting my human capital (earnings) into financial capital (investments).

Now at the age of 41, I’ve managed to turn $1.4 million of human capital into long-term savings, or financial capital, of nearly $700,000 (ignoring the equity in our home).

I can estimate my financial capital into the future by adding my annual savings rate and multiplying it by the expected rate of return on my investments. So when I do that projection I add annual savings of $18,000 to my existing financial capital and multiply that by an expected 6% return on investment. The result?

By age 55 I’ll have converted $3 million worth of human capital into more than $1.8 million in financial capital.

Interestingly, the two forms of wealth building don’t intersect until age 48 – the point when I’ll have about $1M worth of human capital left (assuming age 55 retirement) and my financial capital eclipses the $1.1M mark.

Is Your Career a Stock or a Bond?

Another way to look at the concept of human capital vs. financial capital is to determine the volatility of your career. A teacher or civil servant likely has rock-solid job security and a relatively known earnings schedule throughout their working lifetime. Their human capital could be considered more bond-like, meaning they can likely afford to invest more of their financial capital in riskier assets like stocks.

Contrast this with someone that works in a boom-or-bust industry like oil & gas, or whose income relies mainly on commissions and bonuses. Their human capital could be considered more stock-like and therefore they can ill-afford to take on much risk in their financial capital and should hold more cash and guaranteed investments to hedge against a volatile profession.

You also can’t discuss human capital without talking about protecting your lifetime earnings with disability insurance, whether that’s through your employer, a private plan, or some combination of the two. One-third of working Canadians will experience a period of disability lasting longer than 90 days during their working lives.

Final thoughts

The concept of human capital is interesting when you consider your lifetime earnings and how to convert that into financial capital to fund your retirement years.

You begin your career with perhaps several million in human capital and likely nothing in financial capital. The goal is for the two to intersect at some point during your working life, hopefully early enough so that your financial capital can provide you with your desired lifestyle in retirement.

$3 million sounds like a LOT of money to earn in a lifetime. But here’s the thing: if you don’t convert even a small portion of your earnings into financial capital then your human capital will eventually run out and you’ll end up with nothing.

As Charles Dickens once said,

“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.”