Broker Check

Don't Ignore Risks to Your Own Human Capital

August 24, 2020

As I talk with families around the country, I have observed some have an aversion to insurance discussions and a bias towards investments and returns. However, that is now changing as we are all faced with health risks from the current pandemic. It is crucial to prioritize the planning decisions of a potential income loss from death or disability over investments. Thankfully, the protection decision making process is not something that needs a tremendous amount of effort or constant intervention over time.

For Generation X, Millennials and the working Generation Z, I generally explain that the contribution from human capital towards wealth building is more important than the investment growth of existing financial assets. Human capital will contribute to the growth of financial assets over time.  Human capital decisions are about the individual’s economic engine that drives current lifestyle, pays down debt, and saving for future lifestyle when one is retired. Investment decisions are about tax efficiency, managing volatility, and generating a rate of return for your financial capital to stay ahead of inflation.

There are two catastrophic events that significantly impact human capital. Specifically, premature death or long-term disability. These can be mitigated by ensuring adequate life and disability insurance. The costs of insurance generally do not detract in any significant way from one’s retirement nest egg, even if one works a full productive life with no untoward events. But rather, the lack of protection could result in ruined financial lives and dreams!

The more time one has left to work, the more important protecting human capital is. For example, consider a 40-year old earning $200,000 a year. What is the wealth potential of that individual over the next 25 years? If we assume a 3% annual incremental wage growth, then the total cumulative dollars earned over the 25 years is on the order of $7.1 million. Relative to where the 40-year old individual may be in terms of their current financial net worth, the economic present value of this $7.1 million would likely be much larger. Assuming the same 3% discount rate, the present value of this $7.1 million is $3.4 million today. Therefore, if we think logically, rather than emotionally, it would make sense to protect human capital from risk before focusing all our efforts on investing to grow the existing financial assets. From an emotional perspective, what does our earnings provide? It provides for our current and future quality of life, and for those around us that we love. It allows us to take vacations, pay for our children’s education, live in nice homes and neighborhoods, drive nice cars, support extended family if required, fund charitable causes, and so many other things.

Recently there is a greater proliferation of folks in our communities that crowd fund for challenging life events like deaths, accidents or disabilities. This should signal that folks are not necessarily making decisions about protecting their income, and hence families are relying on community goodwill. In any case, if that and the recent pandemic is not a wake-up call to think about human capital, I don’t know what is! Please think about your life and disability protection. It is not enough to just check a box based on work benefits as this may not be adequate or enough. Please reach out to me or your existing qualified advisors if you need help on these very important decisions.