Wealth Accumulation and Human Capital

Wednesday 14 September 2016

Industry insights

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The relationship between human capital, financial capital and total wealth is an important concept to understand. Grasping it allows informed decisions to be made when purchasing a life insurance policy or total and permanent disability cover (TPD).

  1. Human capital is the present value of future employment income. It is at its highest point at the beginning of your working career declining over your working life and reaches zero at retirement. Although it is not tradeable, it is typically the single largest component of total wealth we possess in our early working life.
  2. Financial capital encompasses traditional assets which are accumulated over your lifetime including property, stocks, bonds etc. Typically, it increases as you move through your working career. Financial capital is the dominant component of total wealth in later life as we pay down home loans, accumulate super and acquire more assets.
  3. Total wealth is the sum of human and financial capital. It is represented by the light blue line in the chart below.


Worked example

To explain the chart further we provide a worked example.

Let’s assume you start full-time work at 25, work for 41 years then retire. Let’s also assume you earn $50,000 each year until you retire. By the time you retire you will have earned a total of $2,050,000 over your working career. If we discount your total future earnings by inflation, we can calculate how much that amount is worth today. This is known as the present value (PV) of human capital. Each year the present value of your human capital declines because you have one less year of future employment income.

At the same time, you are building your wealth by saving and investing in assets. We assume you start with $50,000 and are able to save 10% of your salary each year. We also assume that you invest this at a 6% return and from these assumptions we can derive your financial capital curve which grows exponentially due to the compounding effect.

As you can see in the graph, financial capital overtakes human capital around the age of 50. This is significant as your financial assets exceed the present value of your human capital.


Most people do not include human capital in their total wealth however, it is vital to protect it against unforeseen events. To protect human capital, it is important that you take out life insurance and TPD at the start of your working career. When human capital and financial capital intersect, life insurance and TPD cover are no longer required. Your financial capital is adequate and able to offset the human capital segment of your total wealth.

Individuals tend to avoid thinking about injuries and sickness especially in their youth. Life insurance is often only considered in the later stages of life when it is less important. This is the opposite of what is necessary. We recommend consulting a financial professional in order to ascertain the appropriate level of cover for yourself and your family.

We hope that with this bit of knowledge you will be better equipped for the discussion.

The information provided in this document is of a general nature only, is not personal investment advice and has been prepared without taking into account your investment objectives, financial situation or particular needs (including financial and taxation issues). Investors should read and consider the investment in full and seek advice from their financial adviser or other professional adviser before deciding to invest.

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