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Your Real Net Worth

Last Updated Jan 5, 2010 6:20 PM EST

Professor Moshe Milevsky

There may be no arithmetic exercise more depressing in 2009 than
toting up your personal balance sheet. On the one side are your incredibly
shrinking assets — your 401(k), your home, your mutual funds. On the
other are your liabilities — mortgage, student loan, credit card
balances — whose value never seems to budge. Subtract the unmoving
from the incredibly shrinking and you have what remains of your net worth.

But there's an error in this conventional calculation,
says Moshe Milevsky, a professor at York University in Toronto. It leaves out
your most valuable asset: your lifetime earning potential, known to economists
as your human capital.

By treating your human capital as the asset it is, you get a
more accurate picture of where you stand — and probably a rosier one
than you'd get just from looking at your financial assets.

himself had to make an important decision regarding his human capital early on,
when he was a graduate student. After his father died of cancer, he had to help
his family plan their finances. He wound up switching his focus from math and
physics to finance and economics. The effect on his earning power was powerful:
He is now a tenured professor, a book author, and a widely recognized innovator
in the fields of insurance and retirement planning. He recently talked to MoneyWatch.

In your new book, Are You a Stock or a Bond?, you make much of evaluating
your human capital. What is it?

The concept
of human capital
goes back to the famous economist Gary Becker at the
University of Chicago, who won a Nobel Prize for this almost 20 years ago. The
idea is that people are endowed with more than just their portfolio of stocks
and bonds and a house and what they might have in the bank. What they really
have is the value of their human capital, which is their potential to work.

an exercise I do with my graduate students. I ask them to write down on their
personal balance sheet all the assets on the left-hand side and all the
liabilities on the right-hand side. They think a traditional balance sheet is
assets like money and savings, and then liabilities like student loans and
credit card debt. So they all think they have negative net worth.

But their net worth is actually positive?

Yes, because
they have 40 years of work ahead of them. The value of their wages over a very
long time means that [they’re] almost like an oil well. They may have
very few traditional assets on their balance sheet. But because they’re
young, they have human capital that over the course of their life they’re
going to convert into financial capital.

Younger folks
are much wealthier than you think. When I talk to audiences about this,
especially the older crowd, 40s and 50s, I ask them with a show of hands how
much of their money they’re willing to give away to turn back the
clock 20 years. And most people say, “Take it all, and make me 20
years younger.” What people start to realize is that their human
capital is the most valuable asset they have — more valuable than
financial capital.

What can people do now when evaluating their human capital? What’s
the best way to nurture it?

If you want
to evaluate your human capital, start before your first job. Your first year in
college, you’re trying to figure out what to major in. You should
study things that would increase the value of your human capital, instead of
just taking courses that sound interesting. Once you accept that education is
an investment in your human capital, the task of defining and evaluating it
starts before you graduate.

why you shouldn’t be reluctant to take on student loan debt,
especially when considering going to graduate school. People have debts, and
often they don’t want to go back to graduate school until they’ve
paid off their undergraduate debt. But your student loans don’t
compare to the present value of your human capital, which is in the millions of
dollars. Debt isn’t evil in that context when you’re
investing in human capital.

How should someone in midcareer who just lost their $100,000-a-year job think about their human capital?

At the age of
40, you’ve got a long time to live. So, you might seriously consider
going back to school and retraining, even if it takes another year or two. You’ve
got 20 years of [drawing from] human capital ahead of you. Invest in it, even
if you train in a completely different area. I would not dissuade people from
investing in human capital at that age.

As your book states, assessing your worth partly involves figuring out if you’re a stock or a bond. How do you mean?

It depends on
what you do for a living. The only people who are shopping in malls right now
are teachers and firemen and police officers and federal and state employees.
They all have steady jobs. They know they’re unionized and they have
a guaranteed labor stream. They’re basically bonds.

take a police officer who retires at 52. There’s no reason why, even
though he’s retired, he can’t take on an enormous amount of
equity exposure. After all, his pension is a secure bond. The bonds are the
ones who are going to spend us out of this recession, so to speak. They’re
the ones who can afford to take the risk [to keep spending].

And if your career is less stable, then you’re
more like a stock and so you should invest more conservatively?

Right. If
your human capital is risky, you shouldn’t take chances with your
financial capital. Invest in more secure instruments like bonds. And I tell
this over and over again to the many generations of MBA students here at the
university. They’re all really bright students, and they’re
going to get very good jobs, [but] then they’ll take their financial
capital and invest it very riskily as well. They shouldn’t.

So as a professor ― as a bond ― have you invested in a
portfolio of stocks?

Yes, and it’s
been decimated over the last six months. I lost 45 percent of the value of the
portfolio. But I am — and continue to be — aggressively
invested in equities. My human capital is a bond. I’m a tenured
professor at a university. The last six months have been horrendous, yes, but I
don’t look at that statement until I’ve valued my human
capital at the same time. I want to see the whole balance sheet, not just a
piece of it.

I value my human
capital once a year and I figure out the present value of my projected wages
for the next 30 years, plus the pension that follows. My human capital has gone
up probably more than my financial capital has gone down. I don’t
regret the decision to invest in stocks. I regret the outcome, but not my

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