Mon 29 Oct 2007
When we think of retirement nowadays, we may not realize that the idea is a relatively modern concept. Conventional “retirement” was a new notion, invented only 126 years ago by German Chancellor Otto von Bismarck. His idea was to retire the older members of the national workforce, in order to free up jobs for Germany’s young people.
An astute politician, Bismarck was less interested in their economic well-being than in avoiding potential social unrest. He knew that when young people have no work prospects, they often inconveniently turn to revolution as an outlet for their energy.
Fast-forward from 1881 to 2007, and the concept of retirement is in flux once again. The conventional standard doesn’t fit into our lives as well as it used to, when people would often work for the same company all their lives. Today we live longer, we have different skill sets, and we perceive the work-life balance differently. In short, we face retirement challenges unknown in Otto’s day.
One such challenge is that many lifelong professionals have no particular desire to stop productive work simply because they reach a certain age. For instance, I have a good friend who runs a successful law practice. He figures he can earn a six-figure consulting income in his “retirement” by sitting on a few professional boards, and offering his accumulated wisdom for hire.
Then there’s people like entrepreneurial coach Dan Sullivan, co-author of the best-selling book Laws of Lifetime Growth: Always Make Your Future Bigger Than Your Past. Dan’s over 60, yet he talks about increasing his business tenfold over the next 25 years.
And we likely all know other creative people who love what they do so much they don’t want to stop. (Even the article you’re reading right now was overhauled by my personal editor, who tells me she’ll never retire from her work – a good thing, as my spelling and grammar need so much attention.)
But there’s one problem with retirement today: people are living so much longer that we now need huge amounts of capital to finance a non-working period that could last for 30 years or more. Because of this, we need to carefully examine our definition of “capital.”
There are two aspects to consider. The first, the one we all know about, sits like a behemoth front and centre of any financial planning: dollar capital, otherwise known as retirement savings. If you combine a 30-year retirement projection with the inflation rate, and throw in a Monte Carlo analysis, you get a required figure that’s in the multi-million-dollar range.
The other aspect is one that most projections tend to ignore: human capital. Simply put, it represents the value of your skills: the amount of income you’re capable of generating through whatever work you choose to still do. (You might also term it “continued earning potential.”)
The people I mentioned above are good examples of human capital. If they choose, they can generate income at any age – depending on how much they decide to work, and on how much the market is willing to pay for their abilities.
In Bismarck’s day, the human capital of most workers was all spent during their short lifespans of back-breaking toil. If you think about it, when average life expectancy was 61, retiring at 65 was no big deal. But it is a big deal today, when you stand a good chance of living until 80 or even a hundred.
So your “human capital” is much more valuable than you might believe. When you work after retirement, every $40,000 you earn is actually worth $1,000,000. Human capital is indexed to inflation since work is worth more when prices go up, and since it takes $1,000,000 to earn $40,000 per year (if we assume a 4% real return), most of us are worth quite a bit of capital.
I’ll leave you with two thoughts. One, be wary of conventional financial-planning models. They often call for impossible savings, and their assumptions are not necessarily rooted in your own personal reality.
And two, make sure that you look after your human capital. As Dan Sullivan reminds us in his book, your future always has the potential to be bigger than your past.
Alan MacDonald is an investment advisor who helps high tech entrepreneurs make smart decisions about money. Contact Alan at Alan.Macdonald@RichardsonGMP.com
Alan MacDonald CFA CFP
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