Financial capital and Human Capital

First let me walk you through what each means. 

Think of financial capital as money that you are willing to invest in traditional investments such as stocks, bonds, fixed deposits or alternative investments such as real estate, hedge funds or commodities. An individual has higher financial capital with increasing age.

Now one may say they you do not enough money to buy financial assets and they are wrong. We will address this later in the article.

Human capital can be best thought of as gaining experience through work that one can be engaged in to make a living. Human capital decreases with increasing age and is highest at the start of career.

Human capital is gods’ gift and the more we put into this, we may get more out of it. By this I mean, the more efforts you take to develop human capital (Education and skills), more it will help build financial capital.

Now try to fit yourself into shoes of this definition. Do you have high human or financial capital or both? Some are very lucky to have both since young age. A few need to work their way up to building asset column on their balance sheet. Don’t worry, we got you covered and hope example below can be of most help to you.

With little financial capital:

Let me begin by using John as an example. John comes from not-so-rich family with a modest house as the only financial asset. He is young and wants to increase his wealth over time. However, John has something invaluable that can be his biggest asset. ‘John has very high human capital’ and can use this to build a corpus over longer time horizon. Him being an IT fanatic works at a major IT firm in California and bags home a handsome pay cheque every month. One of the best financial advice John could get it to save and invest to secure his financial future.

“Saving is the first step in investing”

At the early stages of his career, John has high human capital and skills to climb up corporate ladder, or even start his new business once he has sufficient funds. John should avoid the lure of throwing away money and should develop an investment plans that would yield him greater fruits at later stages of his life.

‘Cutting down unnecessary expenses will leave help build a capital base for investment’

For those with less understanding of capital markets can follow low cost strategy through index funds and follow a strict principle of investing monthly whatsoever.

‘To be a stock market investor one needs a lot of money’ - A MYTH

The biggest advantage of equity markets is that it allows one to buy part stake into businesses that he/she desires to buy. After careful analysis, one can invest into businesses within their circle of competence. In other words, businesses they best understand.

‘Stock market investing is risky’

Not investing in stock market is even more risky. Let’s say your human capital is high and that you plan to put your saved money in fixed deposit or guaranteed funds. These assets don’t yield much and barely beat inflation. Money not needed is better served in equity markets as it is the only asset class that beats inflation. One can argue real estate is the other asset class that beats inflation but that is if you have informational advantage over others. Real estate tend to be heterogenous in nature and illiquid.

With lots of financial and human capital: 

Let me now begin by using Charles as an example. Charles comes from a rich family with lots of money in real estate. He is young and wants to protect his wealth and also get richer over time. ‘Charles has both high human and financial capital’. The best advice for Charles would be to explore unchartered waters which could deliver enormous gains and also manage risk to ensure his standard of living stays unaffected. 

Charles has high financial capital that is concentrated into single asset (real estate). He must focus on diversifying his portfolio into other asset classes such as equity and bonds. A right portfolio would be a proper mix of different asset classes to protect downside and also achieve above market returns. Young people can afford to have higher allocation to equities as any money lost can be made up from human capital.

An individual with large financial capital would still need proper capital allocation strategy given his/her risk willingness and ability. Staying too concentrated in an asset class or even a single business can be very risky.

I hope these two examples can help you identify where you stand. You can drop me an email at [email protected]to develop a more detailed financial plan to help secure your future and increase asset column of your balance sheet. We are passionate about researching on business that we would recommend to our clients to achieve healthy returns.