Human capital is defined as the present value (see section “Present vs. Future Value”) of future labor income, which can be considered a dividend on one’s human capital. Although this asset is not tradable, it is often the largest one an investor possesses. Human capital is inherently linked to you, so you cannot spread this risk. Your income stream is essentially an asset, but it is subject to factors such as your industry, career choices, and health. Human capital risk — specifically labor income risk — is arguably the most important risk people face.
Understanding Human Capital Volatility Human capital, your ability to generate income over your lifetime, is a dynamic and fluctuating asset influenced by both personal and external factors. Its value evolves as circumstances change, making it essential to understand how these factors interact and impact your financial decisions.
These factors can be broadly categorized as:
An individual’s age, health, skills, and education all contribute to their earning potential and, consequently, the value of their human capital. For example, acquiring new skills or improving one’s health can increase future earning capacity and raise human capital value. These factors are within your control, meaning proactive investments in self-improvement can increase your human capital value.
External factors such as job security, industry volatility, and macroeconomic conditions can significantly impact future income streams and introduce uncertainty into human capital valuations. A software engineer in a booming tech sector may experience rapid income growth, while someone in a cyclical industry like construction may face unpredictable earnings. Recessions or inflationary periods can reduce job opportunities and suppress wages.
Economic instability often pushes individuals to invest in their human capital as a form of self-insurance.52 For example, during a recession, you might pursue additional certifications or training to improve employability and safeguard against job loss. This adaptability highlights the importance of continuously upgrading your skills to remain competitive in the labor market and highlights the relationship between human capital and economic conditions.
Factors Influencing Human Capital Volatility Several factors can influence the volatility of an individual’s human capital:
The risks associated with human capital — wage earnings, mortality, and longevity — need careful management. Diversifying financial capital to hedge these risks is essential. Portfolio recommendations should consider the correlation between an investor’s financial and human capital to optimize risk management.