We take personal financial decisions based on what we perceive as our assets and liabilities are. Young people who did not inherit much financial assets, often fall in the trap of a conservative mindset thinking that they do not have enough assets to take financial risks. This is faulty thinking given that the most valuable asset young people generally have is their ability to earn, i.e. dividends from their skills will constitute the largest cash-flows in their future. This is why financial thinking must incorporate the earning ability a.k.a. Human Capital as an asset. Doing this enables us to maintain and grow the biggest asset we have along with taking prudent financial decisions.

2. SAM GHOSH
Human Capital in
Personal Finance

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4. Table of contents
WHO AND WHY OF THIS BOOK 1
CAPITAL AND ITS DIFFERENT FORMS? 3
FINANCIAL PLANNING AND HUMAN
CAPITAL 11
HUMAN CAPITAL VALUATION 13
MAINTAINING HUMAN CAPITAL 16

5. WHO AND WHY OF THIS
BOOK
Au​thor In​for​ma​tion
Sam Ghosh is an Investment Advisor and
Founder of Wisejay Pvt. Limited. He has
an MBA in Finance from University of Cal‐
gary, Canada, completed all three levels of
the CFA pro​gram of​fered by the CFA In​si​ti​‐
tute, USA and holds various NISM certifi‐
cates.
Why this book?
We take personal financial decisions
based on what we perceive as our assets
and liabilities are. Young people who did
not inherit much financial assets, often fall
in the trap of a conservative mindset think‐
ing that they do not have enough assets to
take financial risks. This is faulty thinking
1Human Capital in Personal Finance

6. given that the most valuable asset young
people generally have is their ability to
earn, i.e. dividends from their skills will
constitute the largest cash-flows in their fu‐
ture. This is why financial thinking must
incorporate the earning ability a.k.a. Hu‐
man Capital as an asset. Doing this enables
us to maintain and grow the biggest asset
we have along with taking prudent finan‐
cial de​ci​sions.
Copy​right
All rights reserved. No part of this publi‐
cation may be reproduced, distributed, or
transmitted in any form or by any means,
including photocopying, recording, or
other electronic or mechanical methods,
without the prior written permission of
Wisejay Private Limited, except in the case
of brief quotations embodied in critical re‐
views and certain other noncommercial
uses permitted by copyright law. For per‐
mission requests, write to support@
wisejay.com, addressed “Attention: Permis‐
sions Co​or​di​na​tor,” at the ad​dress be​low.
2 Human Capital in Personal Finance

7. CAPITAL AND ITS
DIFFERENT FORMS?
Financial Capital, Human
Capital, Social Capital
Capital is something we invest to gener‐
ate wealth. Wealth on the other hand is the
amount of total resources one individual
owns- a sign of affluence. Wealth can be
invested or spend or squandered around –
hopefully in a descending order of occur‐
rences. The invested part of wealth which
increases future wealth is the capital. Capi‐
tal can also be borrowed especially Finan‐
cial Cap​i​tal.
1. Fi​nan​cial Cap​i​tal – What you own.
As mentioned above, financial wealth
3Human Capital in Personal Finance

8. and Financial Capital are more visible and
understandable and it is easy to confuse Fi‐
nancial Capital with total wealth of an indi‐
vidual. If not inherited, an average person
builds Financial Capital after a certain age
– in the early age an individual generally
borrows capital for education and/or to
build a business and when the investments
in education or in business start giving re‐
turns, the individual invests in financial as‐
sets such as real estate, capital markets as‐
sets or retirement plans etc. In traditional
fi​nan​cial plan​ning and as​set al​lo​ca​tion de​ci​‐
sions, financial assets are given primary
importance mostly because of the tradabil‐
ity and understandability of the Financial
Capital. Do not get me wrong, financial ad‐
visors take the future earnings of the indi‐
vidual into consideration while developing
financial plans as a source of lifestyle main‐
tenance and future savings, but not as a
separate asset with its own return and risk
char​ac​ter​is​tics.
2. Hu​man Cap​i​tal – What you can do.
In economic terms “Human capital is de‐
4 Human Capital in Personal Finance

9. fined as the economic present value of an
investor’s future labor income”. In simple
words, Human Capital is comprised of
skills, knowledge, and capabilities an indi‐
vidual develops to do things for others and
in return earn a living. Education can be
thought as an investment in Human Capi‐
tal. In recent years we have seen a lot of
discussion (mainly on social media) over
the value of education and some people
outright dismiss that education can be any
contributing factor to competence and or
future earnings. Empirical evidence dis‐
agrees. Life​time earn​ings have a strong cor​‐
relation to educational attainments. For ex‐
ample, a study conducted by the US Gov‐
ernment’s Office of Retirement Policy
finds that “Men with bachelor’s degrees
earn approximately $900,000 more in me‐
dian lifetime earnings than high school
graduates. Women with bachelor’s degrees
earn $630,000 more. Men with graduate
degrees earn $1.5 million more in median
lifetime earnings than high school gradu‐
ates. Women with graduate degrees earn
$1.1 mil​lion more.”
5Human Capital in Personal Finance

10. The results mentioned above are statisti‐
cal results and individual cases may vary
based on other factors mainly Social Capi‐
tal. Also, skills can be learned outside
school such as from parents or family,
from the environment in which the child
grows up or the so​cial con​nec​tions the in​di​‐
vidual makes -a case especially relevant for
entrepreneurs. But, what is important to
understand here is Human capital such as
skills and knowl​edge has value.
Let’s get back to economics. As men‐
tioned above Human capital can be quanti‐
fied as the present value of future labor in‐
come and should be considered as a sepa‐
rate asset group with its own return and
risk parameters for asset allocation deci‐
sions. The paper by Ibbotson et al. dis‐
cusses that Human capital can have very
different return and risk natures. For ex‐
ample, a person with a secured govern‐
ment job and a person with a job in which
the earn​ings are highly cor​re​lated with cap​‐
ital market returns- will have very differ‐
ent liquidity (availability of cash) and risk
patterns. So, considering the future earn‐
6 Human Capital in Personal Finance

11. ings as an annuity will not serve the all in‐
vestors well.
Another factor is future investment re‐
quirements in Human Capital. Considering
future earnings as an annuity fails to con‐
sider that fu​ture earn​ings may need fur​ther
investments to develop new skills (because
skills can become irrelevant) or just to
maintain the competitiveness. Although,
major part of future earnings depend on
the Human Capital developed in the early
life, dynamic and sometimes nature of the
skills mar​ket can​not be ig​nored.
3. Social Capital- who do you know and
who knows you.
Will everyone with the same education
and skills earns the same in a lifetime? –
Absolutely not. A major factor contributing
to the differences in earning potential is
the difference is how efficiently the indi‐
vidual is able to put his skills to use and
that depends on how connected the indi‐
vidual is with the opportunities. Like the fi‐
7Human Capital in Personal Finance

12. nancial markets, the skills market is not ef‐
ficient, i.e. skill level does not efficiently
cor​re​spond to re​turn on Hu​man Cap​i​tal.
Social Capital can be described as bene‐
fits and resources available to an individual
from the social (personal and professional)
networks. Social Capital is different from
Human Capital in the manner how it cre‐
ates value – in the case Human Capital,
value is created by the qualities of the indi‐
vidual, whereas in the case of Social Capi‐
tal, value is cre​ated through the in​ter​ac​tions
of the individual with a larger group of in‐
di​vid​u​als.
Social Capital emerges from various
sources-
Bonding: “Bonding social capital refers to
strong, dense ties between people who
know each other well, such as family mem‐
bers, close friends, neigh​bors and mem​bers
of primary groups. Bonding connects indi‐
viduals who are similar in terms of socio-
financial position and demographic char‐
acteristics; groups defined by these rela‐
8 Human Capital in Personal Finance

13. tions thus have a high degree of homo‐
gene​ity”.
Bridg​ing: “Bridging social capital implies
looser ties between people who are not
alike demographically, but have broadly
sim​i​lar fi​nan​cial sta​tus and power.”
Link​ing: Linking ties arise from connec‐
tions between groups and position of au‐
thority and influence. Linking ties include
civil so​ci​eties, gov​ern​ment agen​cies etc.
As it is mentioned above, valuing Social
Capital can be immensely difficult, but we
can understand the sources of value for an
in​di​vid​ual who is a part of a net​work.
Information Benefits: Information benefits
arise from access to information which
may not be available to others or not acces‐
sible as quickly to others. Another informa‐
tion benefit is referral benefits. As men‐
tioned before that equal Human Capital
does to result in the same return in Human
Capital – one of the reasons is access to op‐
por​tu​ni​ties.
Control Benefits: This is the brokerage
9Human Capital in Personal Finance

14. benefit to the individual. People who con‐
nect different groups have access to
‘unique’ information from different groups
rather than ‘redundant’ in-group informa‐
tion. The information broker enjoys con‐
trol over how information may be distrib‐
uted and act as ‘net​work clo​sure’.
Works Cited:
Babaei, H., Ahmad, N., & Gill, S. S. (2012). Bonding,
Bridging and Linking Social Capital and Empower‐
ment Among Squatter Settlements in Tehran, Iran.
World Ap​plied Sci​ences Jour​nal, 119-126.
Burt, R. S. (1997). The con​tin​gent value of so​cial cap​i​‐
tal. Ad​min​is​tra​tive Sci​ence Quar​terly, 339.
Ibbotson, R. G., Milevsky, M. A., Chen, P., & Zhu, K.
X. (2007). Lifetime Financial Advice: Human Capital,
As​set Al​lo​ca​tion and In​sur​ance.
Office of Retirement Policy. (2015, November). RE‐
SEARCH SUMMARY. Retrieved from www.ssa.gov :
https://​www.​ssa.​gov/​ret​irem​entp​olic​y/​research/​
education-​earnings.​pdf
10 Human Capital in Personal Finance

15. FINANCIAL PLANNING
AND HUMAN CAPITAL
The basic steps of Financial Planning – either
simple Goal Based Planning or Comprehensive
Plan​ning are -
a. Determining the current financial situa‐
tion.
b. Developing and financial goals – Neces‐
sary Goals and As​pi​ra​tional Goals.
c. Cre​at​ing a plan to achieve those goals.
d. Create and evaluate alternative paths to
achieve those goals.
e. Im​ple​ment​ing the fi​nan​cial plan
f. Re​view and Re​vise the plan.
One component of evaluating financial
situation is assessment of assets. Asset is a
simple language means something which
11Human Capital in Personal Finance

16. can cre​ate fu​ture cash-in​flows or save cash-
outflows . For example, if you own a car –
it saves your trans​porta​tion cost (hope​fully)
and also if you sell it in the future, you can
get some cash in return. Similarly, if you
own some Mutual Fund units – you can
earn some dividends and get some cash at
re​demp​tion.
But, most of the time our financial plan‐
ning ignores the biggest asset a young per‐
son owns – the present value of his lifelong
earnings which is also called Human Capi‐
tal. Does your financial plan, consider Hu‐
man Cap​i​tal?
Re​lated Link:
Are you conscious about Human Capital
while plan​ning your fi​nances?
12 Human Capital in Personal Finance

17. HUMAN CAPITAL
VALUATION
VALUE OF HU​MAN CAP​I​TAL
The Human Capital can be estimated is
Discounted Cash-Flow method. We can
project the future income till our retire‐
ment from current income and an as‐
sumed growth rate and then discount them
with a proper discounting factor. The dis‐
counting factor is the sum of risk free rate
and risk pre​mium based on the un​cer​tainty
of the future earnings. For example, a per‐
son who earns through commissions has
higher uncertainty about future income
than a person with a secured regular in‐
come. So, even though the person earning
in commission may have higher earnings
currenty, the Human Capital value can be
lesser than the person with secured in‐
come.
13Human Capital in Personal Finance

18. INCORPORATING HUMAN CAPITAL
IN PORT​FO​LIO
When we value a portfolio of different
assets we have to consider the values of in‐
dividual assets and their correlations with
each other. The paper named "Lifetime Fi‐
nancial Advice: Human Capital, Asset Allo‐
cation and Insurance. " by Ibbotson et al.
com​bines the Fi​nan​cial Cap​i​tal and Hu​man
Capital. The utility of the total portfolio is
given as-
Where, W t is the value of Financial Capi‐
tal at the beginning of period ‘t’ and H t is
the Human Capital at the beginning of the
period ‘t’ and γ is the coefficient of relative
risk aver​sion which sig​ni​fies the cor​re​la​tion
be​tween the fi​nan​cial and Hu​man Cap​i​tal.
Works Cited:
Ibbotson, R. G., Milevsky, M. A., Chen, P., & Zhu, K. X.
(2007). Lifetime Financial Advice: Human Capital, Asset Al‐
lo​ca​tion and In​sur​ance.
14 Human Capital in Personal Finance

19. 15Human Capital in Personal Finance

20. MAINTAINING HUMAN
CAPITAL
In simple language Human Capital represents
our long-term earning ability. People often look for
ways to in​crease in​come, but of​ten do not take the
consideration of the uncertainty associated with
such increased income. For example, contract
jobs may of​fer higher earn​ings, but also has an in​‐
her​ent un​cer​tainty. In​crease in​come does not nec​‐
es​sar​ily mean in​creased Hu​man Cap​i​tal.
Two factors influence the value of Human
Capital – Income and Risk Associated with
your income. To increase the value of Hu‐
man Capital you can either increase your
In​come, lower the risk as​so​ci​ated with your
in​come or do both.
Concept of Human Capital as an asset en‐
ables us to think our income ability as mal‐
16 Human Capital in Personal Finance

21. leable and not fixed. Consider you have a
property and you are renting it out. The
rent is lower compared to similar proper‐
ties because of shabby condition. You can
increase the rent income from this prop‐
erty by investing some amount one time.
Likewise, investing in your Human Capital
may increase the long term income ability.
Investing in Human Capital can take the
form of higher ed​u​ca​tion, im​mi​gra​tion to a
different country or investing in social
skills.
Risk associated with Human Capital can be
reduced by opting for a secured job over
commission based or contract jobs. Devel‐
oping a diverse skill set is also one way of
reducing the risk of Human Capital – this
in​creases the pre​dictabil​ity of cash-flows.
Re​lated Link:
Are you conscious about Human Capital
while plan​ning your fi​nances?
17Human Capital in Personal Finance