A person's net worth is generally calculated using a simple process:
- List everything a person owns (or has share/claim over)
- Prescribe a value to each of these items (the total of these values is an individuals gross financial capital value)
- Subtract the value of all debt
This will give the individuals net financial capital value or net worth.
In the higher stratums of society, net worth figures enter unfathomable heights. Jeff Bezos (Amazon CEO) has a net worth of over $US 100 billion, and Bill Gates and Warren Buffett both have about $90 billion each. Australia's richest person by net worth is Blair Parry-Okeden of Scone NSW (about $9 billion) and Donald Trump has about $3 billion in net worth.
Another important way to measure the value of a soul is to look at things beyond the tangible. This doesn't mean how nice someone is (necessarily), but trying to put a value on the likely earnings and expenditures of an individual over their lifetime. This is known as "net wealth".
Calculating net wealth is similar to looking at the intangible assets of a company (e.g. brand value, goodwill, human resource value) in stead of just looking at the financial value of their factories and machinery. The difference between net worth (financial capital) and net wealth is known as human capital.
The major component of human capital is an individual's earning capacity. This is dictated by a few key factors including current income level, education/skills level and expected retirement age. It is essentially the present value of all likely, future payslips or business income. All else being equal, those with more education/skills are likely to have higher human capital values and those approaching retirement are likely to have lower human capital values. Net human capital can be calculated by subtracting the present value of all future living expenses.
Calculating human capital is likely to assist financial planning in two ways:
- Insurance - Essentially, life insurances are purchased to cover the loss of human capital in the event of premature death or disability. So understanding the value of human capital can help to make sure you have the right level of life insurance cover.
- Investing - Human capital can assist in understanding the right level of investment risk to take on. Looking at human capital as a separate investment can help shape the mix between growth and defensive assets. Furthermore, the specific nature of an individual's human capital might dictate other investment decisions. For example, and senior executive for a mining company might benefit from a portfolio with a reduced exposure to mining stocks so as to diversify the exposures in their financial capital with the exposures in their human capital.
Real worth, of course, goes beyond numbers and dollar signs... But that is a discussion for another time.
LBW Wealth Management is an Authorised Representative of Wealthsure Financial Services Pty Limited AFSL 326450
This article has been prepared by LBW's investment committee based on its understanding of current regulatory requirements and laws. It is not considered advice and provides general information pertaining to our ideology surrounding future asset allocation strategies. It does not take into account each client's individual objectives, financial situation or needs. If you would like to know how LBW's understanding of the current environment impacts on your portfolio please contact a Financial Adviser and to discuss your options or before making an investment decisions.
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