A fundamental principle of investment management tells us that no investment is a good one unless we know the investor, and how that investment fits his or her needs. Figuring out timing, your risk appetite, and how far you’ll need to reach beyond your current financial situation to achieve fiscal security and fund your lifestyle are prerequisites for judging any investment. For almost everyone, however, there’s an often-overlooked asset that needs some unique evaluation—your own human capital.
Think of yourself as an asset with earning potential that you own. Like any other asset, your value today is the sum of all your future earnings, discounted by how far in the future and how uncertain each payment will be. Like any asset, you can choose to spend or to reinvest those future payments, and you may be able to borrow money with the promise to pay out future payments to some lender, thereby having more to use today but reducing your “market” value. Once we start thinking about our human capital as an asset in our portfolio, we can think more rationally about our other investments.
In particular we want to ask two questions about the role of our human capital: How can we diversify the overall portfolio to balance the risks and return potential of our earning capacity? And how can we enhance the value of that dominant asset?
The reason many of us start thinking about financial investments—stocks, bonds, real estate, commodities—is that we judge our human capital to be inadequate and want to supplement it. Our earning capacity may be inadequate for several reasons. Most obviously, it may be insufficient to provide for material things, or inadequate to fund an unexpected and urgent need or opportunity. And, of course, we expect our earning capacity to end someday, voluntarily or otherwise, and we’ll need some other way to pay for the grocery bill when our working life runs its course.
In other words, our investments are meant to diversify the risk/return profile of our human capital, something we too rarely attempt to do. You might begin assessing it by asking whether your career earning potential most resembles a living, breathing stock, a bond, or an option. You’re a stock, you expect your earnings to grow throughout your career, but you recognize that they may fluctuate or even stop for a while.
You’re a bond if your income stream is dependable, but unlikely to increase significantly over your working life. And you’re an option if you’re one of the garage entrepreneurs who may reap a billion from an IPO, but is more likely to struggle to pay the rent.
Whichever you are, you can use your financial portfolio to balance the asset you carry in your head. The key is to balance your earning risk with the risk level of your investments. But many of us who qualify as “stocks” tend to seek more risk and potential return when we invest our savings, and many of us who are “bonds” tend to buy more supposedly safe bonds in our financial portfolio. In fact, we would be well advised to do the opposite, not acquiring assets that reflect our earning capacity but those that do not. So, consider bonds if you’re a stock and vice versa. And if you’re an option, you’re probably well advised to keep whatever funds you can under the mattress while you write the algorithms that may make you rich someday.
The other implication of treating your human capital as an asset is the importance of continuing to enhance its value—something that you may not be able to do with other assets. This time of year, unsurprisingly aligned with the clearing of fall semester tuition checks, elicits a stream of studies trying to determine whether higher education is worth the amounts we pay and the income we forego by, at least partially, staying out of the workforce while we pursue the sheepskin. Even for those of us who are well past the time when college was an issue, the results are telling.
One recent Georgetown University study, for example, found median earnings for bachelor’s degree holders to vary from $29,000 for counseling psychology majors to $120,000 for petroleum engineering majors. Or as my father-in-law once told me, “You do what you want; they pay what they want. You do what they want; they pay what you want.” Just as we evaluate companies by their ability to address growing markets with products they can price profitably, we need to evaluate and adjust our human capital in response to changing markets for what we can do and what we can learn to do. That line of thinking has led constructively to renewed emphasis on the STEM subjects—science, technology, engineering and math—and there’s no doubt that we’re more likely to get paid what we want when we can offer such skills to the market. But be careful not to deprecate the “soft” liberal arts disciplines. As former Lockheed Martin CEO Norman Augustine wrote, the liberal arts, especially history “can create critical thinkers who can digest, analyze, and synthesize information and articulate their findings,” competencies Augustine considers “crucial” to success in a tech-heavy organization like his. Those are the skills that can turn a human bond into a human stock.
Jerry Webman is the author of MoneyShift: How to Prosper from What You Can't Control and Chief Economist at OppenheimerFunds.