We use money every day. It is the common currency that we use to trade with others. At its core, personal finance is about our personal human capital, personal financial capital, and how we transact between those using money. So, understanding this framework is central to making good financial decisions and optimally deploying our capital to build wealth. I
The Evolution of Money
From cattle to currency.
Trading amongst people used to happen more directly with the barter system. Over time, people started producing more. They also wised-up to the fact that transacting in livestock, labour, and bulky materials was a bit cumbersome. Plus, livestock poops a lot. Hence, we started using smaller (and marginally less smelly) items, like coins, to represent value. Currency.
From physical to fiat currency.
This currency was either made of (or backed-stopped by the possession of) physical commodities. Gold is probably the most famous example. Unfortunately, securely procuring, storing, and transporting things like gold can be a real hassle for governments issuing money. So, they have now largely moved to “fiat currencies”.
This modern-day legal tender of governments, like the $CAD or $USD, are backed by faith in the assets of their nation. That includes not only the assets of the government, but also the human and financial wealth of its people. Governments can access the wealth of their citizens via their powers of taxation.
We don’t even need physical coins and bills anymore, but can largely transact electronically. This is still done using the fiat currencies of governments. It can be incredibly convenient, but also easy to overspend. The tactile process of using physical money may help deter us from overspending because it elicits more pain when spending it.
The use of electronic transactions instead of cash also makes it much easier for the taxman to come calling if there are attempts to avoid paying your taxes on income or consumption. The so-called “underground economy”. Electronic transactions are easily trackable.
Blockchain “cryptocurrencies” (like Bitcoin) have recently appeared as a potential way to transact while bypassing governments. However, at this point, it is unclear what they are really backed by, they can be stolen or “lost”, and are not readily usable in our day to day lives. I also can’t imagine governments allowing that to change. Governments will want a trackable electronic currency that they control. Buying cryptocurrencies at this point is closer to gambling vs investing.
Our Personal Capital Is The Sum of Our Wealth
Building wealth isn’t just about money. Money is really just the currency used for conveniently making exchanges. But, exchanges between what? Between our human and financial capital.
We possess a certain amount of time, capacity for effort, and useful skills. We also desire a certain degree of comfort and security. This is the “human capital” that we have to spend. We exchange some combination of those things from our human capital pool to make money.
Of the items that constitute human capital, time is an objective and constant measure.
So, it is useful to think of how we buy and sell human capital in terms of time. We sell our time at our job. On the other hand, we also buy time from others to provide services or construct products for us.
We can use excess money to build our “financial capital“. Our financial capital includes financial assets like those held savings or investment accounts. It also encompasses physical assets such as real estate or other alternative investments. Alternative investments can be used to store value. Some, like our luxuriant house or a vintage Stars Wars action figure collection, may even have a dual role. They can increase in value while providing benefits to our human capital by also increasing our comfort, security, or happiness.
Our financial capital can be loaned to service providers (like companies) to hopefully grow more financial capital. That could be as a debt, like through a bond or GIC. Alternatively, we can buy an equity stake in the company as happens when buying stocks. Later, that financial capital can be exchanged back into money via the interest/dividends paid, or through selling the bond or stock.
Money is the intermediary currency between human and financial capital. It is at the center of our economy.
We spend our human capital to make money. Conversely, we spend money to buy human capital from service providers to use their skills, effort, and comfort to preserve or restore some of our own. If we are making more money than we need now, then we can use the excess to build our financial capital for future use.
I sum up this exchange in the diagram below. When applied across a broad group of individuals, this constitutes an economy.
Everyone’s total time is fixed. Spend it wisely.
There are 24 hours in the day for everyone. We also only get a finite amount of time on Earth to spend before we die. We need to spend our personal capital wisely.
This may be a vague concept to teenagers and (surprisingly) even some of the older patients I see in the ICU, but the human body is a mortal machine. Even with maintenance and care, all machines suffer irreparable wear and tear with time. Our ability to convert our human capital into financial capital will diminish with age.
Balance generating capital for the future and consuming it now.
Over our lifespan, we must invest our human capital to generate enough financial capital to draw upon as our human capital wanes. That is the underlying principle behind retirement saving. It is money focused, but money is really only a tool of convenience for exchange.
Along the way, if we generate excess financial capital and our human capital becomes more strained, then spending more money in the present could actually be the best use of our total personal capital. We could buy more time when we need it during the busiest times of our lives. Our money and time are like a titratable drug with a narrow therapeutic window. Don’t forget to adjust the levophed pump.
Personal capital is still only part of our wealth.
So far, we have discussed personal capital. However, our wealth is more than just our personal wealth. We are also impacted by the wealth of the economy and society around us.
Most Canadians have already won the wealth lottery simply by being born here. With some sad exceptions, even our poorer Canadians have access to healthcare, food, shelter, and education. Much of the world still lacks reliable electricity and indoor plumbing/sanitation. For perspective on where your income or net worth places you in the world try this global wealth calculator.
We also build our wealth by growing the capital of the economy and society around us.
On a broader level, by building the economy, we also increase the human and financial capital of our society. That can also support us as we age. A healthy economy will mean more or better service providers to hire. Competition and innovation may make them more efficient and affordable.
Financial capital skimmed from the economy by governments can be used to provide public services. These can benefit us directly (like public healthcare) and indirectly by providing for a more stable and secure society for us to live in.
We can also use our capital to grow the human capital of those around us directly. Those personal relationships could also be a source of support later in our lives. The currency of exchange, in this case, is often “goodwill” rather than money, but can include both. This is about strengthening our local community or broader society. It is analogous to the personal human capital component of our personal wealth.
Holistic wealth is what I am really interested in building.
If we can grow the sum of our human and financial capital (our personal capital) and our economic/societal capital, then that is building true wealth. Using this framework of personal capital within the context of the economy can help us to build more holistic wealth instead of missing the wealth forest for the money trees. It is more of a wide-angle lens to focus through when integrating our personal and financial lives.
In the next post, we will explore how to use our capital to grow holistic wealth.