What’s your net worth?
reprinted with permission from the CFP Let’s Make A Plan blog
Ask any one of the 1.6 million students that the National Center for Education Statistics estimates will graduate from college in 2014, and the answer is bound to be close to or less than zero. On the plus side of the balance sheet might be a car and a checking account. On the negative side is student loan debt, possibly some outstanding credit card balances, and then, of course, the loan used to pay for that automobile.
But to say that newly-minted college grads have no worth is manifestly absurd. What about the value of their degrees, which carry price tags ranging from tens to hundreds of thousands of dollars? Clearly, credit must be given for their education, though it would be incorrect to value this at its cost. What counts is what students do with these degrees.
This valuation question belongs to a branch of economics that focuses on a unique type of asset called “human capital.” Unlike the value of cars which can be easily looked up in the Kelley Blue Book, or publicly-traded stocks which are assessed continuously at prices agreed to by buyers and sellers, the value of human capital is subjective and elusive. One approach is to consider what human capital – as the composite of a person’s education, skills, and experience – can earn in the marketplace over a life span of employment.
In fact, there’s a mathematical formula for human capital very similar to one that is used to evaluate the intrinsic value of any investment. The key variables are current earnings, expected annual growth of earnings, number of years for earnings generation, and the associated risk. A nifty online calculator for this valuation, developed by the economist Moshe Milevsky, is available here: www.qwema.ca/calc/humancapital.aspx.
Just a few minutes spent plugging in some numbers shows the tremendous variation in the results, depending on the assumptions used for variables that are very difficult to specify. Nevertheless, the formula provides important guidance on how young adults embarking on a career can powerfully influence the financial trajectory of their lives.
Here are some strategies for the newly-degreed to consider:
- Do your homework about the salary ranges for any particular career, and be prepared to negotiate. College grads know how to do research, and it’s important to keep this skill sharp when it comes to evaluating job prospects. Knowing the pay range for a given position in a given industry in a given geographical location is essential to being able to negotiate for a good starting salary, and hence for higher lifetime capital. Don’t forget to factor in benefits to your calculation. Get as much information as possible before actually interviewing for a job, including talking to individuals who currently hold the position you are interested in. Without this information, you risk selling yourself short – a mistake that can cost you a huge amount of human capital over your lifetime.
- Learn the expected growth rate for that salary. This rate will be a function of two factors: the growth prospects for the industry and your own performance. Do some future-think about the industries you are considering: how will technology, global trends and demographic changes impact these fields? On a more micro-level, what is the performance criteria you will likely be measured by? Pay attention to both these factors to increase your overall worth.
- Remember that high earnings often entail high risk. Yes, a career in venture capital or in professional sports can pay handsomely, but there is also a significant downside to these occupations – namely, the high and frequent turnover. Consider, too, that even once-secure jobs may now be considered higher risk. Working for the federal government is one notable example.
- View your worth as a matter of time. The human capital equation is based on a lifetime projection of earnings. Naturally, the longer the projected work life, the higher your value. This means that periods out of the work force – perhaps to have children, to care for elderly relatives, to go back to school, to retire early – can significantly decrease your human capital. Decisions about exiting the workplace must be made with full awareness of the costs – not just of foregone earnings, but also benefits, retirement plan contributions and Social Security credits. In short, these exits – while in many cases worthwhile to the quality of our lives – nevertheless need careful planning and financial management. Important, too, is protecting yourself against involuntary downtime from your job, as in the case of an unexpected illness. This makes disability insurance a must for those entering the workforce.
Few college grads appreciate the enormity of their potential human capital and its impact on their financial welfare over their lifetimes. They may assume that thinking about investment will come later, once they deal with debt and find a place to live. In reality, however, they are their own largest, most productive investment. Starting right away to manage the returns and minimize the risks of this investment is, from a financial planning perspective, every bit as smart as getting that college degree.
Just starting out with nothing to invest? Think again…
Read the entire blog and learn more more by visiting here