Building Wealth: Your Human Capital vs. Financial Capital

Back in 2003, when I began my career as a young sales manager in the hospitality industry, I 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 did some back-of-the-napkin calculations and was surprised to learn that I’ve already earned $1 million dollars over my 15-year career. I find that incredible, given that I’ve never earned a six-figure salary and, in fact, my wages have been stagnant for the past four years.

Projecting my income forward using a modest 3 percent annual growth rate reveals the potential to earn another $2 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).

At the age of 38 I’ve managed to turn my $1 million in human capital into long-term savings, or financial capital, of $175,000 (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 percent return on investment. The result?

By age 55 I’ll have converted $3 million worth of human capital into more than $1 million in financial capital.

Interestingly, the two forms of wealth building don’t intersect until age 51 – the point when I’ll have just $667,000 worth of human capital left (assuming age 55 retirement) and my financial capital eclipses the $700,000 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 provide for you in retirement.

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.”

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  1. Pat on October 23, 2017 at 12:43 pm

    Good article Rob. Interesting concept about converting human capital to financial capital over our working lifetimes. The lesson here, in my view, is to wisely use our human capital starting in our early working years and begin diligently to transform it into financial capital so that by the time we finish our working careers we can (hopefully) retire worry free.

    It was interesting that the future intersection of your human capital and financial capital is expected to occur at age 51. I am 62 years old and retired at the age of 60 after a 38 year working career in the energy industry. With perfect hindsight, I looked at my net worth at 60 ( i.e. zero human capital remaining). Based on my estimated average annual income for the last 10 years of my working career (i.e.remaining human capital) and my net worth at age 50 (i.e. financial capital), which I have tracked annually since the age of 40 , I estimated my personal intersection of human and financial capital, to have occurred at age 50…fairly close to your estimated intersection, Rob!

    • Echo on October 23, 2017 at 8:40 pm

      Hi Pat, thanks for your comment. Yes, interesting how your decreasing human capital and rising financial capital also intersected at age 50. With you being such a diligent tracker of net worth, did you know at age 50 that you wanted (or were able) to retire at 60?

      • Pat on October 25, 2017 at 4:19 am

        Yes, Rob at age 50 although I did not have a set retirement age in mind I knew that I would be able to retire financially independently if I worked another 7-10 years.
        It’s interesting that in my case (and it would likely be true, I think for many individuals who retire in their late 50’s or early 60’s), my net worth doubled in my final 10 years of my career. In other words, it took me only 10 years to do what had taken me 28 years to do up to that point.

  2. Jim on October 24, 2017 at 8:52 pm

    Interesting article, Robb, especially the section on whether your career is a stock or bond. Another dimension to this is that most people assume they will choose the age at which their retirement occurs. I have observed friends and coworkers who were laid off in their 50s and couldn’t find another job, or who had health problems that forced them to retire early. My point is that we should strive to hedge our planned retirement date with sufficient financial capital to be able to retire early if circumstances beyond our control arise.

    • Echo on October 24, 2017 at 9:24 pm

      Hi Jim, thanks for your comment. Great point about sometimes not being in control of your retirement date. Another good reason to insure your human capital until you have sufficient financial capital. Building up a 5-10 year cushion helps in case of a lay-off, but sometimes that’s easier said than done.

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