Content area
Full Text
Practitioners and personal finance textbooks generally exclude human capital when constructing balance sheets although this asset represents an individual's earning power and is liquidated over time to meet financial needs. Representing human capital on the balance sheet recognizes its importance as a factor in financial decisions. For many investors, including the value of human capital justifies an increase in the level of risk in the portfolio. The returns from human capital are often hedged with life and disability insurance which can also be incorporated into the financial statement. The intent of this presentation is to initiate a discussion on the place of a contingent asset such as human capital in a household's balance sheet.
Keywords: Personal financial statements, Human capital.
(ProQuest: ... denotes formulae omitted.)
Introduction
A balance sheet is a financial picture of an individual or family at a point in time. Practitioners and personal finance textbooks commonly exclude the value of contingent assets from the balance sheet and thus do not convey an accurate financial picture. For example, a young physician might have a negative net worth if human capital is excluded from the balance sheet. His financial picture appears much worse than it really is. The physician has made a significant investment in his education in terms of both time and money, but the conventional balance sheet assigns this investment a value of zero. The physician's income statement clearly demonstrates his ability to earn a good salary. A financial institution would likely lend him money based on his future earnings; evidently the financial institution recognizes the value of his human capital.
Bodie, Merton, and Samuelson (1992) show that human capital significantly influences an individual's saving, consumption, and investment portfolio decisions over his life cycle. For example, younger people can generally invest a greater percentage of their investment portfolio in stocks because they have the ability to increase the amount of labor they supply to make up for losses. If individuals cannot accurately assess the value of their human capital, they make suboptimal financial decisions. Therefore, there is a need for the practitioner to assist an individual in assessing the value of human capital.
This presentation challenges the conventional approach by arguing that human capital is a significant asset for many people...