Investors go crazy about their stocks and investments. They read balance sheets, annual reports and check their portfolios every hour. Fair enough. It is reasonable that there is a lot of interest because, after all, investors put their hard-earned money into stocks. However, at the same time, they ignore some other things that might even be more important than the daily stock movements. Especially in the first half of life, stocks should not have the highest relevance in asset management. Our investments in human capital and time are much more important than care and diligence in stock investments. In the first half of life, these are the two biggest assets investors have.
The biggest assets investors have: human capital/market value is one of them
Imagine an investor approaches you and wants to invest money profitably. He doesn’t want to buy your watch or your shares, but he wants to have 5 percent of your income every year for the rest of your and his life. How much money would this investor have to give you? 100,000, 200,000, or even 1 million? Let’s say you make a deal of 100,000. Even this shallow figure would put your current market value at 2 million. I’m pretty sure that this value exceeds the value of most of my readers’ portfolios. This analogy illustrates the importance and value of human capital and goes back to Warren Buffett. I like it as it provides a simple shift in perspective away from the raw portfolio numbers to human market capitalization. The analogy also illustrates the potential of one’ s human capital. Let’s look at it in a little more detail.
Human capital has the biggest impact in the first half of our lives
This market capitalization is the biggest asset for most people, especially in the first half of life. You can see this, for example, in the fact that salaries are highest in the 40s and 50s. This is when people have reached the peak of their careers. The human capital allows for a rich and juicy cash flow that is so large that people can live off it, go on vacation, and even save. The picture below shows the median annual earnings for full-time employees in the United Kingdom. The figures are from Statista.
The distribution is similar in other nations. The figures show impressively: the years of life in the 40s and 50s are the most lucrative. This also shows us that human capital is a powerful asset because statistically, it creates increasing income every year until 50.
Later on, human capital recedes somewhat into the background
Later in life, the increase in income that human capital can generate decreases. But that is only in the second half of life or even later. Nevertheless, we cannot deny that human capital thus also loses market capitalization. The investor from the above analogy will no longer be willing to invest the same amount in a 50-year-old as in a 25-year-old who is about to graduate from university.
Other asset classes come to the fore in the second half of life. The development of Warren Buffett’s wealth is a good example. As you can see below, Warren Buffett made most of his fortune when he was over 50 years old. Please note that the statistic is from 2015. The current net worth of Warren Buffett is currently twice as high, amounting to $ 114 billion. But also look here how fluctuating the development was in the first half of his life. At 44, Warren Buffett’s net worth has dropped from $34 billion to $19 billion.
We see that the volatility in the stock markets is much higher than in the development of the salary, which is very consistent in the first half. This consistency has several advantages. For example, it provides planning security. People with a high level of human capital usually have no difficulty finding a job. This allows them to maintain a monthly cash flow, which helps them start a family, buy a house (all these things are assets), etc.
Why increasing the market value of our human capital is so important
Of course, it could also happen now that Berkshire Hathaway’s holdings collapse, dragging Warren Buffet’s net worth down with them. Still, time has led to an accumulation of profits, and Warren Buffett’s net worth is large enough to weather such setbacks easily. But, as I said, time takes its time to work. However, in the case of active income generated by human capital, it is the other way around.
Compared to other asset classes, human capital brings relatively high returns initially, while the gains from other asset classes like stocks or dividends only compound over time. And this is precisely the reason to invest in human capital from the beginning. Because this way, the return we generate with our human capital becomes bigger and bigger and can create a significant cash flow tsunami for decades.
Only these liquid funds put many investors in a position to buy a significant pile of stocks or ETFs in the first place, which then creates the effect of compound interest in the second half of life, as it did for Warren Buffett. If we put these two curves on top of each other, the following picture emerges:
In a life not influenced by special effects such as an inheritance or winnings in the casino or gambling, the blue curve is closely related to the orange one. The active income from the blue curve lays the foundation for building up a fortune that enables passive income in the second half of life.
The human capital decides whether we can enjoy hedonistic life
The chart above also shows that we live on the income from our human capital throughout the first half of our lives. It is, therefore, the time when we are at our fittest and most independent. It is when we can discover the world, spend time with friends and start families.
Thus, our human capital also determines how we spend this vital time. Do we spend it frugally because we want to escape the ominous hamster wheel “corporate world,” or do we step on the gas, work hard, party hard, and enjoy life and the ever-increasing income from our human capital? I prefer this hedonistic way of life.
Because one thing we have to be aware of is that life gets lonelier as we get older. This is another reason why human capital should bring me the highest possible return so that I can enjoy life without financial-related worries and fears.
The biggest assets investors have: time is the second one
Time in all its effects is a complex construct and ultimately the driving force behind everything. Without time there would be no cause and no effect. Time cannot be stopped and applies equally to all people and is, therefore, a fair good, available to all people to the same extent.
Time provides no leverage
Because time works the same for all people, time does not offer any leverage in the conventional sense. Or rather, I would not consider time as a lever. Because after all, we can’t use the time to shorten time. Instead, it works the other way around: we look for ways to use our time effectively, i.e., to reduce the time we need for a result. Here, many investors seek an immediate reward. In the same way, investors try to save time and shorten the path to wealth.
But they overlook what a critical asset time is. We just have to realize how to use time in the right way. Especially the beginning is crucial because it sets the cause for an effect whose impact will only occur decades later. And we all know from physics: the stronger the input, the greater the output. So we can state: time itself is not a lever. Instead, it is about leveraging time.
We can leverage time by compounding
An hour is an hour. We cannot change anything about it. But we can influence what happens during this hour. So we can leverage the output of time if we increase the input. And this effect is precisely what happens to our passive income when we increase the initial capital.
Because then, the compounding effect has enough room to come into effect. As a result, it creates exponential growth, which we humans find difficult to deal with. The human brain tends to misinterpret such exponential growth. But with exponential growth, a high impact can be achieved by small investments over a long period, and an even higher impact can be achieved with even higher investments. So the better we use our human capital, the greater the basis for exponential growth and the higher the net worth in the second half of our lives.
Exponential growth and compound interests
Time and antifragility
I cannot emphasize enough that time has another essential function. Time smoothes out all extremes and is an excellent means to achieve antifragility. I have already described this train of thought several times (for example, here) and do not want to repeat myself, so to cut it short:
Time allows evolutionary mechanisms to take effect here as well. Little by little, time exposes the unsuitable strategies that may have been successful for a few years but ultimately failed. A portfolio invested for the long term and broadly diversified also makes use of this effect, only it takes a little longer to have an impact. In such a portfolio, for example, an ETF, time will automatically weed out all the bad companies and let the good, strong, and successful ones prosper.
With “time in the market”, investors automatically benefit from this evolutionary mechanism. Their portfolio becomes antifragile without lifting a finger. So, in the long run, these investors with their broad investment style have good chances to be more successful than the typical investor.
Therefore, time is an excellent tool in many ways. It helps us to show which of the new-fangled theories or methods are bullshit and what has been able to withstand all the falsification attempts. Time smoothes out excitement. It also helps us reduce complexity because it peels away the fragile elements and leaves behind antifragility. And time teaches us to be patient.
Time is, therefore, an asset that investors should use as quickly as possible. In addition, they should also focus on maximizing the impact.
Biggest mistakes and misconceptions
Finally, I would like to point out general errors and misconceptions that result from the above considerations. They, therefore, also serve as a good summary.
Ignoring the potential of the biggest assets
Human capital is the biggest asset in terms of market capitalization for many investors in the first half of their lives. From a risk management perspective, this is almost dangerous news. Investors are lugging around a massive chunk of risk despite a healthy stock portfolio. The only problem is that we cannot avoid this risk. Every human being faces this risk.
But the good thing is that with that risk also comes a huge opportunity. That is why it makes sense to fully exploit the human capital at a young age to take advantage of the opportunities that come with it. Because only the transfer of active income into a passive income can reduce the dependence on human capital. It is almost paradoxical: To reduce dependency as much as possible in the long term, it is necessary for the short and mid-term, i.e., in the first half of life, to put all chips on human capital.
Greater focus on investments in equities than on investments in human capital
The salary that most private investors earn is the cash flow of human capital. This cash flow is often referred to as “active income”. The term “active income” usually has a negative connotation for many investors. Therefore, many investors put more emphasis on investing in equities as quickly as possible. But in doing so, they lose sight of their human capital and the opportunities that come with it, especially the opportunity to build up a high basis for passive income.
It worsens when investors forego investments in human capital (e.g., through further education) to buy shares instead. Thereby they completely forget that the market capitalization of the human capital is much larger than their depot. In this respect, a return on this human capital also brings more money than the same return on their equities.
Following a “becoming-rich-quickly” scheme
Many people who have not invested enough in their human capital try to increase passive income elsewhere through “becoming-rich-quickly” schemes. As a result, they invest in particularly risky investments. They follow hype stocks and shady recommendations. I have seen investors who have never heard the words P/E ratio or value investing, yet they have gone all-in on Palantir and Bitcoin.
Following the “corporate world is bad” narrative
Another aspect I don’t understand with many investors is the constant repetition of the “the corporate world is bad” narrative. I also feel the desire to quit and say “fuck it” sometimes. But after reflecting for a few minutes, I quickly abandon the idea. Ultimately, it’s crazy, and I would go so far as to call it BS. I mean, think about it. I want to invest in companies. Fine. But I also want to escape this world simultaneously, which is an apparent inconsistency in my thinking.
First, the financial leverage of a career is quite impressive. Second, the despised “corporate world” offers many advantages for developing the right skills and mindsets. These levers need energy, and I can only speak from my perspective. But I think it’s worth putting energy into these levers, especially at a young age. I have also written a detailed article about this, which you can find here.
No, the corporate world is not bad in itself, and I really think that FIRE is the wrong narrative. It may sound harsh, but the truth is: it’s not the corporate world that is bad to you. It’s your human capital that is just too low. Few understand this.