When considering asset classes, most investors think of things such as stocks and bonds, commodities or real estate. Each of these assets represents a form of capital as each serves to generate and enhance the wealth of the individual or business that owns the asset. While tangible assets are apparent and readily understood, "human capital" is intangible, and perhaps a bit more unfamiliar.
Quite simply, human capital is the education, training, skill and knowledge that an individual possesses, and unlike other forms of capital, it is unique to each person. While difficult to quantify in monetary terms, human capital may be one of the most valuable assets that an individual possesses as it may serve as a barometer of one's current and future earning capacity. If one has invested time and money in higher education, or to become a specialist in a given field, he or she has made an investment in his or her human capital. As such, this person may likely earn a higher level of income than will an individual of similar age who has a more limited education. Over time, people can increase the value of their human capital through additional education or on-the-job training. Indeed, anything that one does to increase his knowledge or enhance her skill set is an investment in human capital that typically increases the person's value in the workforce.
Human Capital and Your Portfolio
So given that human capital is an intangible asset unique to each individual, how might it factor into one's overall investment portfolio?
Just as prudent investors diversify their portfolios to gain exposure to domestic and international securities, growth and value stocks, the stocks of large and small companies, as well as different types of bonds, human capital can be viewed as one more asset class that, in our opinion, should be similarly considered when building a diversified portfolio.
For example, most of us likely know people who own the stock of the company that they work for in their employer sponsored retirement plans. While these people may feel loyal to the company and believe that their employer firm's stock is a solid investment, in reality, they may be tying their human capital too closely to the investments in their retirement plan. Should the company ever fall on hard times, or go out of business entirely, the employees may well lose their jobs, and to make matters worse, their retirement plan values may plummet along with the value of their company's stock.
Case in point is the collapse of the Bear Stearns retirement plan in 2008. As of January 2007, Bear Stearns was worth $20 billion 1 . However, risky business practices and massive exposure to subprime mortgages caused customers and investors to lose confidence in the company, and the value of Bear Stearns' stock sank bringing the company's value to about $1.1 billion. 1 Unfortunately, not only did the employees of the firm who collectively held approximately one-third of the company's stock in their retirement plans 2 see their nest eggs virtually disappear into thin air, but there was rampant speculation that up to half of the company's 14,000 employees
could lose their jobs through layoffs. 3 If these employees had diversified their human capital away from the assets that they held in their retirement plans, even though they may have lost their jobs, they may have been able to preserve the lion's share of their retirement assets.
Consider, as well, the human capital of a software developer at a start-up technology firm as it may relate to his overall asset allocation. Since this individual is employed in the technology field, it's likely that the firm may be classified as a growth company. Similarly, given that the firm is a start-up company, the employee is very likely exposed to many of the same risks that are typically associated with small cap stocks.
When creating an asset allocation that considers both his human capital and financial capital, this employee may be wise to underweight exposure to small cap growth stocks while overweighting areas such as large cap growth, value stocks, and international securities. Additionally, based on the individual's time horizon and risk tolerance, an allocation to fixed income may be prudent as a means to mitigate the equity risk in his portfolio.
Human Capital: Understanding the Risks
Just as there are various risks associated with financial assets, there are risks to human capital as well; primarily, the risk of death or disability, as well as professional competency risk. 4 Given that human capital is a fundamental determinant of one's income and lifestyle, we believe it's prudent to protect it by insuring yourself
against a premature death, or a disability that may leave you unable to work either temporarily, or permanently. In doing so, you are protecting yourself and your family against a loss of income that may occur if your human capital is unexpectedly compromised.
Professional competency risk, on the other hand, is the risk that your competence, knowledge, and skill-set may become obsolete - thus devaluing your human capital - if you fail to stay current with the latest trends, developments and information that are pertinent to your field. By continually investing in your human capital through on-going education and training, professional competency risk may be greatly diminished.
While often overlooked, we believe human capital is a real and valuable asset class that should be protected, and that should be carefully considered when evaluating one's overall asset allocation. Please contact us if you have questions about human capital, or if you'd like to discuss how it relates to your investment portfolio.
Symmetry Partners, LLC and "Broker-dealer" are unaffiliated.
Content written by Symmetry Partners, LLC. Our firm utilizes Symmetry Partners, LLC for investment management services. Symmetry Partners, LLC, is an investment adviser registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. All data is from sources believed to be reliable, but cannot be guaranteed or warranted. No current or prospective client should assume that future performance of any specific investment, investment strategy, product or non-related investment content made reference to directly or indirectly in this article will be profitable. As with any investment strategy, there is a possibility of profitability as well as loss. Symmetry follows a passive investment strategy that involves limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Passively managed portfolios are designed to closely track their respective benchmark index rather than seek out performance. As a result, the portfolio may hold securities regardless of the current or projected performance of a specific security or particular industry or market sector. Maintaining investments in securities regardless of market conditions or the performance of a specific security could cause the portfolio to lose value if the market as a whole falls. Please note that you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Symmetry Partners or your advisor.
Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk.
Diversification does not protect against loss of principal.
Please be advised that Symmetry Partners, LLC does not provide tax or legal advice and nothing either stated or implied here should be inferred as providing such advice. The information is provided for educational purposes only. Please be advised that Symmetry Partners is merely relaying this information and has no control if some of the timelines are amended.