Focus more on putting your own human capital to work, and less on financial products
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It's ugly out there. Millions of people have lost a major part of their financial assets. Millions more have seen the value of their homes decline. So let's talk about what's left: human capital.
It's the forgotten part of personal finance. One reason is that the financial services industry is entirely focused on products it sells: financial assets. But human capital is important because it is the primary asset we all have.
Consider a simple example: How much you would need to replace your paycheck. A worker who earns $50,000 and who may have 20 more years to work would need about $1 million in financial assets to replace his ability to work, his human capital. A more precise estimate would have to deal with inflation, wage gains, and skills.
For years I have recommended that younger workers avoid debt, defer homeownership, and have a stash of cash rather than stocks. Why? Because they are the most important asset they have. A young worker's ability to negotiate a better salary depends entirely on her freedom from debt and the ability to pursue opportunity. Her financial capital - her savings - is best used as a tool to leverage her human capital.
The task all human beings face is to employ their human capital - their ability to work - and convert it to financial assets. That's how we can sustain ourselves when we can no longer work, or choose not to work.
The idea is emerging rapidly:
We're going to hear a lot more about human capital. One indication is the Morningstar catalog. An article in it discusses human capital and takes issue with target date mutual funds: "Today's investors face a choice of target date funds that range widely in their equity allocations - and have no way to gauge which is most appropriate." Funds maturing in 2010, for instance, have equity allocations from 79 percent down to 28 percent. They can't all be right.
In fact, retirement-year allocation depends on age at retirement, whether you have a defined-benefit pension, and other factors. A worker with large Social Security benefits, a hefty pension, and a mortgage-free house can put much more in equities than one with mortgage payments, no pension, and smaller Social Security benefits.
Scott Burns is a syndicated columnist. He can be reached at scott@scottburns.com.
