What is your
most valuable asset? Your business? Your house? Your investment portfolio? The
pile of gold buried in your backyard? What would you guess?
If you
guessed anything tangible, you guessed wrong. Your most valuable asset is what
economists call your human capital. This is the sum total of the skills
knowledge and wisdom you possess which you then trade with your employer or
your customers for money.
When you are
young, human capital represents the lion share of your total wealth. As you age
and begin to accumulate other assets, human capital becomes a smaller
proportion but still is your largest asset.
If that is
so, and economists tell us it is, then your biggest risk is not being sued if
someone slips and falls in your driveway, a protracted bear market or the cost
of long-term healthcare. Your biggest risk is disability or obsolescence. Both
have the potential to seriously disrupt your income.
Think of it.
As long as my income stream keeps flowing, I can get through almost everything
else. Suppose someone does slip and fall in my driveway. They sue me and the
court awards them millions of dollars. I may file for bankruptcy but the court
will allow me to keep enough of my income to keep a roof over my head and feed
and clothe my family.
Imagine we
experience a depression which takes thirty years for stock prices to recover
from. As long as I donât lose my job and I can still work, I can still eat.
Imagine I work in a family business that continues to pay me long after I have
become old and feeble. Long term healthcare is not a problem.
I am not
saying life would be champagne and caviar. I am just saying it would be better
than the alternative. A steady income solves many problems. Loss of one can
wreak havoc.
Disability
We have two
choices when it comes to risk. We can either hedge it or insure it. Insuring a
risk is almost always more costly than hedging it because the intermediaries,
namely insurance companies, have to make a profit over and above the cost of
the hedge.
We can insure
the risk of disability by purchasing disability insurance. Some employers offer
disability insurance as an employee benefit. Disability policies can be either
short term or long term.
Short term
disability policies pay you a percentage of your salary if you are temporarily
unable to work because of injury or illness. A typical policy will you anywhere
from 50% to 65% of your pay for anywhere from two weeks to two years, depending
on the policy you purchase. A period of 13 to 26 weeks is more common and then
long-term disability kicks in if you have it.
Long-term
disability replaces income for a much longer period of time. Policies usually
limit benefits to five years or age 65, whichever comes first.
Of course,
being the optimists that we are, no one likes to think about what happens if
disaster strikes. But the question asked by a Family CFO most often has to be,
âWhat if?â
Data from the
American Council of Life Insurers tells us one in seven will experience a
disability lasting more than five years. The odds increase to one in five for
those of us between the ages of 35 and 65.28 It turns out the leading cause of
disabilities is not freak accidents, as many people think, but instead is
caused by devastating illnesses such as cancer or heart disease. The long-term
loss of income is so disruptive that 46% of home foreclosures are due to
medical disability.
Obsolescence
You cannot
insure against obsolescence but you can hedge against the risk. How? By making
constant upgrades to the software between your ears. The best hedge against
being replaced by a 23 year old whiz kid is lifelong learning.
Lifelong
learning need not be formal to be effective. I had the pleasure of interviewing
Dr. Benoit Mandlebrot for my radio show several years ago. Dr. Mandlebrot is a
mathematician who is best known as the father of fractal geometry. Fractal
geometry is what makes the stunning reality of modern day computer animation
possible.
Dr.
Mandlebrot's accomplishments are unique in that he has been awarded major
prizes not just in mathematics but also in physics, medicine, science and
technology. His concepts have also been applied to economics, earth sciences
and linguistics.
Dr.
Mandlebrot credits his ability to think outside the traditional confines of a
single branch of science to his unconventional education. He said in one
interview, "To tell the truth, and not to sound pretentious, but circumstances
prevented me from acquiring a real college or university education in the
traditional sense, so I am primarily self taught."
Passive income
Disability
and obsolescence can both be hedged by building a portfolio which produces
enough passive income to pay all the bills, as described in chapter 14. When
passive income equals or exceeds day-to-day living expenses, work is no longer
a necessity, it is a choice.
For my
husband Jim and I, we use a combination of passive income and disability
insurance to hedge our risk. Because I am the public face of our company, if I
were to become disabled, our business would be seriously impacted. But we still
have employees and bills to pay.
We have a
disability policy on me which specifically covers the overhead of the business
in the event I am disabled. We rely on the passive income from our investments
to replace our income from the business.
Longevity
Americans'
increasing longevity can be an economic blessing or a curse. Provided we remain
healthy, increased longevity increases our human capital. If our mental and
physical health declines as we age, our human capital is diminished.
Thus, there
is one other thing you can do to increase your odds of financial success and it
has nothing to do with saving or investing. Take care of your body and your
mind. Quit smoking, eat right and exercise. These are as much a part of
achieving lasting financial success as a sound investment strategy.
The
preceding is an excerpt from Kim Snider's yet-to-be published - but getting closer book, "The Family
CFO's Guide to Financial Success." This book should be available in bookstores everywhere (don't you agree?), but
isn't - until Kim stops procrastinating on the second draft!
Kim Snider, Kim Snider Financial Communications and/or Snider Advisors
make no representation that the information and opinions expressed are
accurate, complete or current. The opinions expressed should not be construed
as financial, legal, tax, or other advice and are provided for informational
purposes only. Call 866-952-0100 to request the Snider
Investment Method⢠Owner's Manual, which includes a description of the
Snider Investment Method, investment objectives, risks, suitability and other
information. Please read and consider carefully before investing. All
investments are subject to risk including possible loss of principal.
