Tuesday, 26 May 2015 - 20:00

 

Charts

Human & Financial Capital

I was involved in a very interesting discussion with a client in the past week regarding the future value of assets and the role this plays your existing investment portfolio. Most advisers would (or at least should) take great care in estimating the future value of an investment portfolio in order to plan for a client’s retirement. There are an innumerable number of calculation methods and tools available to assist clients in this very important part of their lives.

It is a well-known fact that any shortfalls in the current level of your assets need to be covered with an insurance policy. The capital shortfall to cover your dependants is made up with a life insurance policy while your future earnings can be insured with an income protection policy. There are definitely many more uses for broader life insurance products but for the topic of discussion the above will suffice. With the above 2 products we insure very real assets, albeit assets we would only realise in the future.

What this means is that most individuals have a very constant total level of wealth throughout their lifetime, your total capital. Your total capital is made up by your Financial capital (the assets already accumulated) and Human capital (the assets that you will still earn/procure over the course of your life). The 2 pools of capital are interlinked and both should be regarded with equal diligence.

Below is a graphic illustration of how the real levels of Human and Financial capital change over time:

Note the Total capital remains unchanged throughout the measured time period, as it is the sum of Human and Financial capital.

The most daring assumption in the above graph, and consequently the topic of discussion, is the fact that contributions are made and increased consistently and without interruptions. This may be a realistic assumption for someone employed with the same company throughout their career following a linear path to the top. For such an investor, the Human capital is very predictable and stable, it is also fully absorbed into Financial capital. Although not a realistic assumption it is nigh impossible to account for potential future losses in your Human capital portfolio.

The more predictable your Human capital over time the more risk you can allow in your Financial capital. If your Human capital is volatile, think of an entrepreneur or an individual remunerated largely with performance bonuses, you cannot quite allow for the same measure of risk in the Financial portfolio. These individuals face a risk that the Human capital is not fully absorbed into Financial capital. The converse is also true that they might end up with more Financial capital than estimated.

Incorporating the profile of your Human capital into longer term planning goes a long way in helping investors reach their goals. If the value of your Human capital is not predictable over time you may be required to delve into your Financial capital at some stage. This means that not all of your assets can be invested into a growth oriented strategy, regardless of your age or willingness to assume risk, as an untimely redemption out of a growth strategy can lead an investor to sustain losses.

I concluded the discussion with the statement that an investment portfolio can contain a certain amount of risk in both your Financial and Human capital. The riskier your Human capital the less risk you can take up in your Financial capital and vice versa.

We, at Seed, take great care to be cognisant of the various factors important in effectively managing our clients’ assets. We also understand that each client has unique circumstances that requires thorough and diligent consideration.

Kind regards,

Stefan Keeve

Tue, 26 May 2015

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