Most people think of building wealth as increasing their net worth. Someone’s net worth is their financial assets minus their financial liabilities. This and other methods can be used to gauge your financial progress. However, that still misses the human capital half the picture.
Many will agree that without your health, you have nothing. While as unpredictable as financial markets, our health needs to be part of the plan. Our time left on Earth and capacity for effort are limited and shrink with each passing moment – so we need to spend this capital wisely.
As described in the preceding post, building holistic wealth encompasses the sum of both our human and financial capital in the context of our broader society and economy.
Building Wealth Over The Lifecycle
How we exchange between our human and financial capital will change over our lifespans. When we start out, we usually have plenty of human capital and very little financial capital. The unfortunate reality is that as we age, there will be a decline in our human capital and we need to build sufficient financial capital before then.
That is retirement planning – building financial capital now to draw upon in the future to maintain our lifestyle when we have less human capital left.
To build that financial capital, we need to spend less than we earn. Simple. However, the difficult part is that we don’t really know the time scale of when our career or life may end. You don’t want to sacrifice too much for a future that doesn’t come – YOLO and FOMO. We need to balance working and spending now with our probable future need. Fortunately, this is made easier by investing – and doing so early.
Using our newfound holistic wealth perspective, let’s broaden this traditional view of financial planning to inform our investing and holistic wealth building. The same principles apply to different permutations of both our human and financial capital.
Investing Financial Capital To Make More Financial Capital
This is most readily thought of as investing in physical or financial assets that grow (like stocks and bonds). That involves risking your money in the investment. That risk could be low, like buying government bonds, and associated with a lower expected return. Or it could be riskier, with a higher expected return, such as equity investments. Getting that balance of risk and reward by mixing these different types of investments is called asset allocation.
Include your human and financial capital when choosing your asset allocation.
Choosing an optimal asset allocation means taking on enough investment risk to get good returns, balanced with enough stability to avoid making behavioral mistakes. That usually means a mix of stocks (for return) and bonds (for stability). However, including your human capital as an asset in your decision making is also important.
Early in your career, you have plenty of human capital.
Although not risk-free, it is likely that you have many years of earning money before you need to access your financial capital. Your human capital acts as part of your “bond allocation”. It gives you more risk capacity (the ability to recover from an investment loss). To make ensure that this part of your asset allocation is low-risk (as intended), be sure to get the appropriate amount of own-occupation disability insurance.
As you age, your ability to work like a beast (and the years left to do so) shrinks.
The time horizon before needing to access your financial capital to make up for your waning human capital shrinks. You may need to add more bonds to make up for this. This gradual shift to decrease financial capital risk is sometimes referred to as the “glide path”. There are even target-date funds that emulate the concept. The shifting asset allocation of the Vanguard U.S. Target Date Fund is shown below as an example. Bonds are shades of blue and equity is red/orange.
Many rules of thumb are bantered around for optimizing this relationship. However, it is important to remember that while you may have the capacity to recover from a financial down-draft – you also need the investing intestinal fortitude. Our objective risk capacity and our emotional risk tolerance are not the same things.
Invest your human and financial capital early.
Time-frame is key to successful investing. Early investment of financial capital results in an outsized result. This is because compounding returns increase exponentially with longer time-frames. For example, investing $15K/yr instead of $10K/yr for five years makes a difference of $175K after 35 years of compounding at 6%/yr.
That extra $25K early on makes a seven-fold difference down the road. The good news is that “early on” is also when you have more human capital. You could increase your early investing by spending some of that human capital.
Using Human Capital To Build Financial Capital
You can spend human capital by giving up some comforts through spending less for a few years. “Living like a resident” isn’t too bad. A resident salary is in the 75th to 95th percentile compared to age-matched Canadians. You don’t need to go the route of extreme frugality, but you also don’t need to follow harmful physician scripts.
On the other side of the ledger, coming out of residency, you are already accustomed to hard work. You could pick up a physician side hustle. That extra work early on, when your human capital is highest, can help you to be able to work less sooner and in a more sustained way.
You could also invest some human capital to build a passive income stream. Outside of passive income from investing financial assets, truly passive income streams usually mean building a business or inventing/creating something. Done well, that front-loaded time/effort yields disproportionately more income with little time/effort later. Writing a popular book would be a good example. Writing a niche blog that requires frequent detailed new/updated posts definitely is not.
Again, the impact of spending this human capital early to invest and let compounding work for you is bigger than if done later in life. It is also harder to do later if you have less human capital to draw upon.
Investing Human Capital To Build or Preserve Human Capital
The preceding discussion about investing your human capital to build financial capital is pretty standard basic personal finance. However, financial wealth is only part of our wealth equation. We also need to invest our human capital to preserve or grow more human capital if we want to be truly wealthy.
That means putting in the time, effort, and emotional risk required to build and sustain relationships. Getting enough broccoli and exercise. Recharging our emotional battery and sense of purpose with some form of spirituality. Developing and sharpening our minds with new skills. It takes some deliberate effort to reclaim some leisure time in a busy life.
Analogous to financial investing, an early start with building human capital is important.
Some happiness research suggests that our relationships are probably the strongest predictors of happiness over our lifespans. It is harder to suddenly start building a relationship with your kids when they are teenagers or adults than when they are young and think you are fun and cool. Well, my kids never thought I was cool. I am fun though.
If you envision a retirement filled with hanging out with your spouse and/or friends, then you need to nurture those relationships in advance.
Developing a satisfying level of expertise and skill in new hobbies requires time and effort. The process of doing that is also punctuated by small victories and pleasures. Why not start that now?
The effects of diet and exercise accrue over a span of years or decades. Plus, entrenched habits become progressively more difficult to change. Don’t wait until your first myocardial infarction.
Growing the economy around us.
As discussed in the preceding post, we build our personal capital in the context of our economy and society.
Growing our economy benefits us by fostering innovation and productivity.
It occurs naturally when we exchange money for services and products. If we are all uber-frugal and rarely spend money, then there wouldn’t be much impetus for providers to put in the effort. The economy would grind to a halt. That promotion of spending may seem like the antithesis of personal finance dogma, but it isn’t.
The key: spend money on areas that you value and not on what you don’t.
That both makes the best use of our limited money and also contributes in a small way to the broader market. Collectively, it shapes which fruit will ripen and which will wither on the vine.
For example, our family spends considerable money on athletic activities, travel, and our home. We spend relatively little on clothing. We spend nothing on cigarettes.
In a small fractional way, we are encouraging the part of our economy that provides great travel experiences or athletic development. Conversely, we are not supporting the growth of the tobacco industry. As individual consumers, our impact is likely small. However, it doesn’t really cost us much to make good choices and it does make us feel good. Plus, all larger-scale impacts start with individual actions.
Spending less than we make also allows us to invest. Investing your money in productive companies not only helps your personal financial capital grow, but it also promotes growth in the areas of the economy that you invest in.
We could take that a step further and invest in “socially conscious” funds. However, we haven’t at this point. White Coat Investor has a nice summary of the pros/cons of the Environmental, Social, Governance investment philosophy.
Building our social wealth.
We can build social wealth both indirectly through our government, and directly through our personal relationships. Building the economy around us, as described above, helps to build the wealth of our society. Both via the jobs created and the taxes collected from successful businesses. Governments use those taxes to provide social programs and national security.
Governments also procure funding via our personal income taxes when we sell our time and through consumption taxes when we buy back time/effort from others.
In trying to build the society around us, should we then pay more tax?
The answer to that depends on whether you feel that your capital is put to best use via the government or more directly. Government programs have the advantage of scale. However, with that complexity, there can also be a loss of efficiency to bureaucracy if it becomes too large. Further, political decisions about capital allocation are influenced by political advancement and not just optimal resource utilization. There are aspects to improving our lives that governments do well and others that they don’t.
You can probably guess by the time spent on this blog focused on tax-efficient investing that I don’t feel that paying more tax is the best use of my capital. That is not because I am greedy and want to stunt the growth of our society.
It is because my wife and I already pay a large tax bill and feel that further deployment of our capital to build society is best done more directly. We are blessed with the ability to make a large income – but that also means that we are responsible to steward that money to see that it does the most good.
Make giving part of your wealth-building plan.
While media seems to highlight this aspect of personal finance around Christmas time each year, giving regularly is a key part of good financial health year-round. It may even seem contradictory to those trying to earn and aggressively save towards the goal of financial independence, but it is important to give along the way.
It is also vital to remember that the giving of our personal capital includes both our financial and human capital. We can give a combination of money and/or our time and effort. Similar to retirement saving, we may have more human capital to give in our early careers and more of our financial capital later in life.
We can even smooth our income and shift our tax-burden, similar to an RRSP, using a donor-advised fund. These funds give a tax credit now and can be allocated to charity in a later year. There are fees for these funds but they could be useful if you plan to move from a very high-income to a relatively low one in the near future. We may use one in our final few years before retirement. That could shift some tax without impairing our giving in the present.
Giving money through-out our lives has some important benefits.
It reminds us that money is just a tool. In fact, giving money to a worthy cause usually brings more happiness than simply spending it on stuff. Giving is an optimal use of the money tool. Giving regularly also makes it a habit.
Early in our lives, while we are raising our kids, this is probably a habit that we want to model and instill in them. Be careful to focus on the intrinsic purpose of the giving.
Others witnessing your generosity could be inspired to give. Emphasizing “giving achievements” with extrinsic validation may even be effective for motivating selfish wealthy people. However, that ultimately steals some of their holistic wealth if it becomes the focus rather than a byproduct.
Our family usually gives anonymously, when possible, for this reason. It also makes for fun family secrets and the joy of seeing the appreciation of the recipients without it being tempered by drawing awkward attention to our financial wealth.
Similar to the other aspects of building wealth, investing early through developing a habit of charity yields the best results over our lifetimes.
Building Holistic Wealth With A Balanced Personal Capital Perspective
Be deliberate. There are many competing interests for your personal capital. Career, kids, family, self-care, community. The balance will different for everyone. However, have a broad perspective as you buy, sell, and grow your personal capital helps to do so deliberately.
An early start is key. As you move through life, take stock and adjust course accordingly to find and restore balance. If you steward your capital well and grow it, you will be wealthier if you also better the world in which you live at the same time.
Since our time is fixed, optimally building wealth requires us to use our time efficiently. The common currency of exchange between our time and capital is money. So, our Time-Money Exchange Rate (TiMER) is key to our efficiency. Yes, I made that up because it sounds catchy. We’ll explore that concept and how to maximize our TiMER in a future post.