Human Capital Bests Investment Capital
Human Capital Bests Investment Capital
We love to dream of getting the best returns on our capital. We read books, peruse blogs, and even take courses. Is real estate better than stocks and bonds? Should I be jumping into crowdfunding or syndication? 
Index investing vs stock picking? Everyone thinks they know the answer. And depending on the what’s happening in the world at the moment, the market can be beaten. Some inefficiencies still exist that allow double-digit returns as the norm. Real estate investors, in fact, feel like they can wallop the stock market most of the time. In this post, however, I’m going to tell you the exact opposite. In my humble opinion, chasing returns is fruitless. Not because of the ease of index investing or the theory of reversion to the mean. Not because of the unknown or unknowable. I worry little about returns, and yet feel like my wealth accumulation skills are far better than average. It all hinges on one basic principle. Human capital bests investment capital. Every time.
The Cost of Human Capital
Human capital is not free. It takes very little training or knowledge to do manual labor. But for most of us professionals, our skills came at a price. We front-loaded the investment by sacrificing both economically and intellectually. We suffered through the ivory tower and ran up debts that had to be diffused in the beginning of our careers.
Skills and on the job training can last a lifetime. While I spent hundreds of thousands of dollars on my education as a doctor during the training phase, continuing education and maintenance of certification are now a paltry portion of my yearly expenses.
Once paid for, human capital bests investment capital. It consumes nothing but energy.
Investment Capital Consumes Itself
I have a friend who FIREd and now does hard money lending. He loves it. He figures that he can safely and consistently make 10% returns. Therefore, he allocates a million dollars of capital to this asset class. Based on his math, he should accumulate $100,000 a year from this investment. This exceeds the average 6-8% that I make with basic index investing. He is beating the market with very little downside. He usually spends a few hours a week setting up deals and reviewing properties.
So, for working (3 x 52) 156 hours he makes $100,000 and he ends up with $1,100,000 at the end of the year.
I, on the other hand, pay very little attention to returns and use my human capital instead. I take my million dollars and put it in an S&P 500 index. This takes zero time and thought. If I average a 7% return, I will end up with $70K at year’s end. This is far poorer than my friends 10% return.
So how do I come out ahead?
I leverage my human capital. I use my specialized training and knowledge as a physician to do a lazy side hustle that I find enjoyable. Lets say I spend 8 hours a week as a medical director and make $100K extra. My time allotment is far more than the 3 hours my friend spends doing his “job”, but it still pales compared to full-time employment.
By years end, I have accumulated $1,170,000 compared to my friends $1,100,000 at the cost of 260 hours.
Not a bad trade-off (tax not factored in).
Human Capital is Resilient
Human capital bests investment capital for other reasons also:
- It is much more recession resistant. Even in a poor economy you still have your skills and knowledge.
- It keeps your knowledge base current. After retiring for a few years, it is often hard to return to a profession if the field has changed at all.
- Even in retirement, working a few hours a week can add structure and personal interaction to an otherwise isolating lifestyle.
Final Thoughts
Human capital bests investment capital for many reasons. Since the sacrifice is front loaded, the cost of human capital has already been paid for early in a person’s career and is essentially free. Unlike investment capital, human capital doesn’t consume itself.
And if you are worried about recession or sequence of returns risk, it might just be your best asset class option.
The cost of hiring just one person at my agency is exorbitant, yet we don’t spend enough time vetting people. Our human capital is what makes us run but we don’t focus on it enough.
A common mistake, I think.
One of your last points is my favorite. Human capital is recession resistant. This is why it’s probably good to work a year or two longer than FI, save a little more, and let that pot of money grow. This prevents the massive hit that sequence of return risks can cause. Oh, and have enough cash after you retire to continue to let the pot grow before you catch it.
Unfortunately, it feels like far too few people use their human capital to “save enough.” After all of that front-loading of time and money for education, we just blow it all 2/2 delayed gratification.
TPP
Yep. Most FIRE people still make some money. Recession proof is the goal.
Imho both have their place. After all things like disability endanger human capital but not investments. Diversifying by having both streams seems to be the best solution.
True. Human capital has its limits.
Fulltimefinance is correct imho, human capital wears out. It’s hard to consider that when you are 45 but at 65 when the end comes into view you realize making even more is wasting your time
You mean I won’t stay 45?
The only thing I disagree is your statement, “Unlike investment capital, human capital doesn’t consume itself.”
I actually think it is the other way around. In my post, “Become A Capitalist, not A Laborer,” I think of investment capital as an untiring worker that works 7 days/wk 24/7. This money creates more money which can then be redeployed as well, compounding the money earned the next go around. The original capital does not get consumed (unless it is poorly invested) at all but creates a self-perpetuating money generating machine.
Human capital on the other hand does get consumed. If I want to make 2 million dollars as a radiologist, I am sure I can do it if I choose to read every single minute of the day hundreds and hundreds of studies. However I would truly be destroying myself in the process. I would have mental fatigue, eye strain, and just all sorts of issues that doing that amount of work would entail. I would be consuming myself and thus destroying the human capital.
As was already pointed out, human capital only has a finite lifespan (cognitive/physical decline is inevitable). At that point investment capital will still be going on unphased and actually growing stronger.
You need both (human capital early on to get enough money to start the investment capital machine going), but in my mind investment capital will always win hands down. I plan on living on passive income streams from this when my human capital has been almost entirely consumed.
Investment capital consumes itself. Once used, it can only make its basic return. Human capital starts with nothing and produces something.
I like it DocG! I side gig primarily to keep my cognitive abilities sharp and my network and brand strong . But I also end up with a significant income from only a few hours of work a week. More than if I spent that time managing rental property or tweaking my investments. xrayvsn makes good points as well. As much as I’m disinclined to give MD’s very much credit, since I lean toward the obvious truth that most of the truly clever people majored in engineering, you guys are ok. Don’t even get me started about lawyers!
I know some really smart engineers.
My education was the best investment I ever made. Our medical degrees are a ticket to high income. When you funnel that into passive income streams you’ve got a powerful 1-2 punch. I’m hoping my ROI is FI.
It was for me.
Really good points. Wealth really is human capital at the end of it all. Even applying your accumulated wealth requires human capital to make it grow.
RE limits what you can build upon over a lifetime. The skills and effort you or your family put in is what builds wealth. Our ability is, in and of itself, a form of wealth.
Thanks for a good read.
-Bull…
Ability is wealth. I like that.