Human Capital

Human capital is the present value of all future wages and earnings an individual expects to receive over their working life. For most people under 50, human capital dwarfs financial capital — it is by far their largest asset.

Human capital behaves like a bond in several important ways:

• It produces a stream of cash flows (paychecks) over a defined horizon (working years), similar to coupon payments
• It has duration: a 25-year-old has roughly 40 years of future income, implying very high duration; a 60-year-old has far less
• It is subject to discounting: the present value falls as discount rates rise, and vice versa

The bond-like nature of human capital is the foundation of lifecycle investing. Because young investors already hold a large implicit bond position (their human capital), their optimal financial portfolio tilts heavily toward equities. As human capital depletes through aging, the financial portfolio should gradually shift toward bonds to maintain the same overall risk exposure.

Not all human capital is equally bond-like. A tenured professor's income stream is stable and predictable (high bond character), while a startup founder's income is volatile and equity-correlated (high equity character). The more equity-like an individual's human capital, the less additional equity exposure they need in their financial portfolio.