Your younger clients may be worth more than you (and they) realize
Human capital: young investors’ hidden asset – and trump cardAs shown in the chart below, at the beginning of an investor’s working life, their financial capital is often very small: most 25-year olds haven’t earned much yet – and are likely paying off debt such as student loans. So, at this stage, an investor’s human capital is typically their single largest asset because the present value of their potential to earn and save future income often far outweighs their existing personal balance sheet. Over the course of a working life, though, as an investor saves a portion of their income, their human capital is converted into financial capital. Creating a plan to invest that financial capital is key to helping grow it to a level that will potentially meet their long-term goals. As time goes on, financial capital typically represents an increasingly larger proportion of an investor’s total wealth relative to the value of their human capital. At retirement, a person’s human capital is typically equal to or near zero while their financial wealth is at its peak. For illustrative purposes only. Assumes (1) starting salary of $50,000, which grows in line with 2.5% inflation annually over a 40-year career; (2) investor saves 10% of salary each year beginning at age 26 until age 65; (3) annualized hypothetical investment return of 7% on the full amount saved each year, with no withdrawals. Returns are hypothetical, are not a guarantee of future performance, and are not indicative of any specific investment.
The interplay between an investor’s human capital and their investment portfolioTo help younger investors make their financial capital work harder for them, advisors can help allocate their portfolio to reflect the volatility of their human capital – in addition to striving to manage the more common variables of market volatility and the risks and opportunities of different investment vehicles. To estimate this human capital volatility, consider:
- The volatility of the investor’s current and expected future salaries – for instance, is the investor paid on commission or is their salary relatively stable?
- The likely career path of the investor – are they in a career with a clear route for progress in terms of promotions? Or, are they looking at a limited career trajectory?
- Whether the investor’s salary and marketability are tied to the cycles of the economy and stock market – or whether they are independent of the markets?
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