Advisor Forum preview: The

(November 15, 2004) Advisors who calculate their clients’ net worth using traditional accounting practices are missing the big picture, according to finance professor Moshe Milevsky.

The personal financial balance sheet includes assets and liabilities — subtracting one from the other leaves the client’s net worth. “You probably do this with all your clients,” Milevsky says. “But I think when you look at individuals who are young, this approach is not capturing what these folks are really worth.”

According to Statistics Canada, the median net worth of the average 25-year-old Canadian is just $10,000, Milevsky notes.

“The conclusion is that youngsters don’t have a lot of capital, so the clients you want, in terms of wealth management, would be in the 45-65 region,” he says. “No one wants to target a 25-year old; what assets are there to manage?”

That’s where Milevsky’s “human capital” theory comes in, which he defines as the present value of all the income a person earns over the course of a working life. “So if you’re 25 and you’re studying to become an engineer, then there’s an enormous amount of potential which will translate into income over time. That potential is in the millions of dollars.”

By the time a client reaches retirement age, human capital has declined but there should be lots of financial capital to make up for that loss, he explains.

“If you buy into this way of thinking, the richest people in the population are my students. They have 35 years of earnings ahead of them; their human capital is enormous.”

If you ignore human capital, you’re ignoring your biggest asset, Milevsky warns. “And if what you’re about is wealth management, you ought to make sure you take into account all the assets that are there.”

“For those of you who don’t buy this, I ask you how much financial capital would you give up in exchange for more human capital? I’d love to have a portfolio of human capital. Human capital and financial capital have to be managed over time in similar ways in an integrated balance sheet.”

Milevsky will expand on his theories of total asset allocation at the upcoming Advisor Forum conferences in Vancouver (Nov. 22-23) and Toronto (Dec. 8-9). Check the Advisor Forum website for details.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com