Your human capital—the value of your future earnings—is likely your most significant financial asset, especially if you’re in your career’s early or middle stages. This post breaks down how to estimate your human capital using simple finance concepts like present value and discount rates. You’ll also learn why accounting for mortality and wage growth is essential for realistic planning and how your estimate fits into a broader picture of personal wealth.
What Is Human Capital and Why Should You Care?
Human capital is your potential to earn income over time. Unlike financial capital (stocks, bonds, or real estate), human capital isn’t directly tradable but just as real. It represents the economic value of your skills, knowledge, and experience, translated into wages throughout your work.
Human capital is the largest component of net wealth for most people, especially early in a career. And yet, it’s rarely tracked.
That’s a mistake. If you’re serious about planning for financial independence, understanding your human capital is essential.
The Math Behind Human Capital: Time Value and Mortality
At its core, your human capital is the present value of all the money you expect to earn until retirement, adjusted for the chance that you may not be around to earn it. This sounds morbid, but it’s how life insurance companies, pension actuaries, and long-term planners model reality.
So, let’s tighten the definition:
Human capital is the mortality-adjusted present value of your future earnings.
Here’s how that breaks down:
- Estimate your annual future earnings. Base this on your current salary and expected wage growth.
- Apply a discount rate to reflect the time value of money.
- Adjust each year’s wage by the probability that you’ll live to earn it.
- Sum all those mortality-adjusted, discounted wages to get today’s value of your human capital.
Yes, it’s like pricing a bond; only the cash flows are your future paychecks.
Inputs That Matter: Wage Growth, Discount Rate, and Retirement Age
Your human capital calculation depends on several key data points and assumptions:
- Current Age and Salary: A younger individual has more working years ahead and, thus, a higher human capital base.
- Expected Retirement Age: The longer you plan to work, the more income you can generate.
- Wage Growth Rate: Assume steady increases or align with industry averages.
- Discount Rate: This should reflect inflation and the risk profile of your income. Stable jobs = lower rates; volatile income = higher rates.
- Mortality Adjustments: Based on actuarial tables, survival probabilities help ground the model in reality.
Be thoughtful with these inputs. Assumptions greatly impact the entire financial roadmap.
Getting the Data
Discount Rate: There isn’t an official discount rate for you to use when calculating human capital. U.S. Treasury Yields (e.g., 10-Year Treasury Note) are commonly used as a proxy. To find the current rates, visit the U.S. Department of the Treasury website. For example, if the 10-year Treasury is 4%, you might use that as a baseline. You might also make adjustments to account for the stability of your job. For example, a stable job might use a discount rate a little lower, while startup income would use a higher adjustment.
If you’re projecting nominal wage growth, your discount rate should also be nominal (includes inflation). Inflation projections can be grabbed from the Federal Reserve Economic Data website. Most people know their nominal salary (e.g., $100,000/year) and expect raises in nominal terms (like “a 3% raise next year”).
Mortality Table: You can find mortality tables in a few places. Try the U.S. Social Security Administration (SSA) actuarial table or visit the Society of Actuaries (SOA) to download a copy. The OECD and the World Bank also publish this data.
The Time Value of Money: Why $100 Today Is Not $100 Tomorrow
At the heart of human capital modeling—and all financial planning—is a fundamental concept: the time value of money (TVM). The core idea is this:
A dollar in your hand today is worth more than a dollar you’ll receive in the future.
Why? Because today’s dollar can be invested or put to productive use, earning a return over time. This isn’t just about inflation (though that matters too). It’s about opportunity cost—what you could be earning if you had the money sooner.
When estimating the value of future earnings, you can’t treat next year’s salary the same as this year’s. A paycheck received in 10 or 20 years is less valuable than one received today. So, to fairly compare income across time, we discount future income to the present.
This is exactly what the present value formula helps us do:
Where:
- PV = Present Value (what the future amount is worth today)
- FV = Future Value (how much you expect to earn in a future year)
- r = Discount rate (your assumed rate of return or cost of capital, expressed as a decimal)
- n = Number of years into the future that the payment will be received
If you expect to earn $100,000 in ten years, what is that income worth today? To answer that, you apply a discount rate. For instance, at 3%, the present value of $100,000 earned ten years from now is about $74,409. Add mortality risk, and it’s worth a bit less.
This is why understanding time value is vital: it lets you compare earnings in the future with money in your pocket today.
Practical Implications: From Planning to Protection
What can you do with that insight once you’ve estimated your human capital?
- Financial Planning: Use your human capital value as a key input in your holistic balance sheet.
- Insurance Decisions: Life and disability insurance needs often align closely with the value of your human capital.
- Investment Strategy: Younger professionals with high human capital and low financial capital can afford to take more investment risk.
- Career Strategy: Investing in upskilling or career changes should be evaluated in terms of expected boosts to lifetime earnings.
Limitations and Caveats
No forecast is perfect—and that includes your human capital estimate. It’s a projection, not a promise. While the model gives you a structured view of your future earnings, life doesn’t always follow a spreadsheet.
Here are key variables that can (and likely will) shift over time:
- Career Path Changes: You might switch roles, industries, or take a break from work entirely.
- Retirement Timing: Planned retirement at 65 might turn into 60 or 70.
- Health Events: Illness or injury can reduce your working years or income potential.
- Economic Conditions: Recessions, inflation shocks, or rapid technological shifts can alter wage trajectories.
- Wage Growth Variability: Raises are rarely linear. Some years you leap forward, others you stagnate.
These risks don’t invalidate the model. In fact, they highlight its value. A directional estimate of your human capital is far better than flying blind.
Used wisely, it becomes a strategic tool—helping you identify your financial strengths, protect against downside risks, and make informed decisions about how to invest your time, energy, and capital.
From Here: Integrate Human Capital into Net Wealth
Your net worth today might not reflect your financial potential. Including human capital in your wealth picture gives you a fuller view of your financial capacity and obligations.
Human capital is what fuels your ability to generate financial capital. As you age, you convert one into the other. The better you understand that process, the more equipped you’ll be to make smart, confident decisions about your money and your future.
Disclaimer: All views are my own and do not reflect those of my employer. No confidential information is disclosed here.