Sunday, June 28, 2015

Should We Include Human Capital In Calculating Our Net Worth?

Often times, when we read books or attend workshops related to Personal Finance, one of the exercise that you are requested to do (even before the actual book/workshop started) is to calculate your current Financial Net Worth. It is a simple formula : The sum of all your Assets (cash, investment, CPF balance and properties etc..) MINUS the sum of all your Liabilities (Housing loan, credit cards repayment, car loan etc..). The difference (could be positive or negative) is your Financial Net Worth at the moment. 

Recently, I am reading a book by Moshe A. Milevsky called Your Money Milestones. It kinds of throwing a spanner in the works by introducing Human Capital into the equation and claimed that the above-mentioned formula is flawed. In short, he is of the view that Human Capital is our greatest assets and it should formed of the Asset category. Of course, to strike a balance, he also introduce another equivalent element in the liabilities column called "Estimated Hidden Liabilities" (which I've yet to find out what does it constitutes).

First and foremost, let's focus on the Human Capital. In his book, he defines Human Capital as the present value of the total future after-tax compensation (including wages, salary and bonus) and even provide a link to calculate this value. I tried to access the link but don't seems to be able to find the relevant calculator and hence don't bother to share it out here ;-(

Personally, maybe due to my conservative nature, I don't think it is wise to include Human Capital in deriving our Financial Net Worth and following are my reasoning :

1. Anything related to FUTURE (including compensation) is not guaranteed. 

2. Assuming that the Human Capital will always be more than the Estimated Hidden Liabilities, It will give us a false impression that we have much more Net Worth than we actually have. 

Don't get me wrong, I do agree with him that Human Capital is our greatest assets, just don't think by including it in the calculation will show us our true Net Worth at that time. 

Of course, regardless of what formula we use to calculate our Net Worth, it is just a number, it won't make any real financial differences. What is more important is to use it as a baseline to keep track of the growth/decline of out Net Worth. In short, we need to do this exercise regularly, say annually, as it is only meaningful if we can do the necessary comparison (just like reading the company Annual Report, it is useful if we can compare the year-on-year performances).  

What is your view? 

Cheers!

5 comments:

  1. Our human asset is an asset only when it can generate income; otherwise it will become human liability to our next-of-kin.

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    Replies
    1. Cw8888 : can't agree more with you, that's why I think it should not be part of the net worth calculation ;-)

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    2. agreed with CW. For CW, I think his portfolio will not be a liability to his next-of-kin. haha

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  2. Unless we are in a Slave Owner and Slaves relationship, Skill set of Slaves maybe counted as part of Owner net worth. In today context, I would go with Net worth is the Measure of the Performance of the Human Asset and not itself.

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