What’s Your Human Capital? by Anne Bucciarelli, AllianceBernstein

There’s a critical element to investment planning that younger investors—and their advisors—overlook: the investor’s human capital, or ability to work and save, creating financial capital. Understanding your own human capital is important to determining how much investment risk you can take, particularly if you are young.

Despite the varieties of human talent, you had no human capital when you were born. Your human capital grew because you, your family, and your community invested in your education, as the Display shows. It’s likely to continue growing (in terms of your capacity to save each year) with your work experience, on-the-job training, and perhaps a return to graduate school.

Human Capital

However, the cumulative value of your human capital will also decline with the number of years of working and saving ahead. Sometimes, your financial and human capital will grow together. More often, your financial capital will rise as the other falls, as the Display also shows.

Why does this matter?

If you are a recent college graduate with a steady job and you contribute to your employer’s 401(k) plan from every paycheck, your human capital has a steady bond-like character that increases your ability to take investment risk.

The money you invest in your first year in the company retirement plan—say, $4,000, plus a $2,000 employer match—will be only 2.5% of your total lifetime contributions, if your annual contributions don’t grow. It will be a smaller share of the total, if you boost your contributions in the years to come.

As a result, you should probably invest most of your money in return-seeking investments, such as stocks, if you can tolerate the volatility that would bring. Doing so would begin to build your financial capital.

By contrast, if you are a 25-year-old freelance software developer, your income is probably quite lumpy: You may make a lot of money in some months, and little or none in others. As a result, your savings are likely to be lumpy and uncertain, too. As a contingent worker, you cannot view your human capital as bond-like: It is much more like equities.

If you’re a contingent worker, you need to save for the future and invest for growth, but in long-term savings accounts, you generally shouldn’t take as much risk as a salaried employee. In addition, you probably need to park some of your savings in conservative, liquid assets such as cash and short-term bonds that you can tap to pay the rent and cover other basic living expenses, in months when you don’t receive a big lump payment.

When we work with clients to develop a financial plan, we first consider how much human capital they have, its equity- or bond-like character, and how they can convert it to financial capital. Next, we develop a plan that works with their likely path of human capital to achieve their long-term goals.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.