Personal Finance

Your Greatest Asset: Harnessing the Value of Your Human Capital for Financial Prosperity – Part 1

by Jeffrey Ryall CFA, CFP® - Associate Portfolio Manager at Cardinal Capital Management, Inc.

Transforming your biggest financial asset

As a young professional, you have probably spent countless hours and thousands of dollars completing a post-secondary education program and entering the workforce. This is only the starting point harnessing the value of your human capital – or the economic value of your skills and abilities.

What makes human capital unique, how is it valued, and how do we transform it from our biggest financial asset?

What is human capital?

In its simplest form, human capital is defined as the life-time value of an individual’s acquired skills, knowledge, and experience that can be converted in the marketplace into income (a financial asset).

Early in your career, human capital is usually your largest and most important asset. Human capital will increase in value as your skills, knowledge, and experience are further developed, but will eventually decline as one progresses through their career and wages have been earned. Ultimately, human capital is fully used up by the point of retirement or our death.

Not all human capital is created equally

There are several factors that may influence the value of your human capital:

  • Societal norms and values tend to place different values on occupations in the marketplace.
  • Labour market conditions are influenced by supply and demand for specific skills and knowledge.
  • Specialization and continued investment or maintenance in knowledge and skills tend to be rewarded.
  • Technology can cause temporary or permanent fluctuations in wage values.
  • Riskiness of occupation can demand premiums, such as hazard pay.   

Since the start of the Coronavirus pandemic, you have likely heard or read about how these changing factors have impacted individuals. Travel restrictions have caused an oversupply of workers in the hospitality and tourism industries, while contractors and tradespeople have been in high demand. Professionals have also been impacted; dental practices were forced to close for weeks and physicians who perform elective, non-urgent surgeries have seen their operating hours scrubbed.

Estimate the value of your human capital

Real life tends to be more complicated and uncertain than theories explained with fixed assumptions. An individual’s wages may grow faster or slower, the length of employment may be longer or shorter, and unexpected illnesses may reduce or impair human capital altogether. Nonetheless, one of the most common applications of calculating an estimate for human capital happens during the risk management process (when purchasing life insurance).

At a minimum, one needs to identify the following:

  • Current annual income,
  • Income growth rate, and
  • Length of working years

A 35-year-old physician earning $300,000 annually, planning a 30-year career, may have current human capital valued at ~$5,000,000.

Transform your human capital into financial capital

Without financial assets, when human capital is depleted, there’s no means to fund one’s lifestyle. In light of this, individuals and families must determine how to convert wages into future financial capital effectively. Determining when to spend, save, borrow, or seek protection is vital for maximizing your human capital’s potential throughout your lifetime.

Traditionally, net worth tracks financial asset growth and debt reduction over time for individuals.

Net Worth = Assets – Liabilities

A common example involves families buying a house with a bank mortgage, gradually paying off the balance (plus interest). Over time, the house’s value usually rises while the mortgage shrinks through payments, boosting net worth.

Recognizing the Value of Human Capital in Net Worth

Economists now recognize the substantial value of human capital for individuals early in their careers, reshaping net worth concepts. However, there are many obstacles that can impede one from transforming human capital into other financial assets. Wages can be fully spent if savings are not set aside for your future. Illnesses can reduce or impair human capital before it has been transformed to another financial asset.

In Part II of this article, we will apply these concepts so you can harness the full potential of your human capital.

“Success is not a random act. It arises out of a predictable and powerful set of circumstances and opportunities.”

Malcolm Gladwell, Outliers: The Story of Success

The decisions you make now are cumulative and can influence your finances throughout your working career and into retirement. Everyone has a different ability and willingness to accept risk, lifestyle expectations, and savings capacity. Speak to a financial planner and build a personalized financial plan that works for you and your human capital.

Read the next article in our Harnessing the Value of Your Human Capital series: Part 2.

Notice to Readers: Unless otherwise noted herein, the sources of all performance data is Bloomberg and Cardinal research. This article has been prepared for general informational purposes only, without reference to the investment objectives, financial profile, or risk tolerance of any specific person or entity who may receive it. Investors should seek professional financial advice regarding the appropriateness of investing in any investment strategy or security and no financial decisions should be made on the basis of the information provided in this newsletter.

Jeffrey Ryall
About Jeffrey Ryall

Jeffrey Ryall, CFA, CFP®, is an Associate Portfolio Manager at Cardinal Capital Management, Inc. Jeffrey specializes in developing personalized financial plans and customized investment portfolios for professionals and incorporated business owners, with complex financial needs. If you have a financial planning question, connect with Jeffrey at [email protected] or through LinkedIn.

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