Human Capital Realized – Now What? | Brandon Averill, Justin Dyer | AWM Insights #71
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Episode Summary
We believe that the greatest driver of your net worth is your human capital.
But what about when you reach the phase in your life when you’ve converted all or the majority of your human capital into resources? What are some of the considerations you should be making in relation to your overall financial structure?
This week, Brandon and Justin discuss what to do when you’ve realized all of your human capital including the moves you should be making, tax implications to consider, setting up your priorities for life, and why in the long run financial structure matters more than individual investments.
Episode Highlights
(00:41) The News You Should Know: Delta variant, no spectators at the Olympics, Robinhood valuation, index funds are 50, earnings seasons is here again
(2:12) When your human capital has been converted to resources, what are some of the things you should be considering?
(5:27) Minimizing taxes, charitable giving, and setting your priorities
(7:21) A better strategy than using a Monte Carlo simulation
(8:17) Matching assets with priorities
(11:11) This is a process not an event
(13:56) Your financial structure matters more than the individual investments that you choose
(15:21) Financial structure should be customized to you and your priorities
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Justin Dyer: LinkedIn
Brandon Averill: LinkedIn
+ Read the Transcript
Brandon Averill (00:00):
Hey everybody. Welcome back to AWM Insights. Each week we cut through the noise of what Wall Street is selling you to bring you the knowledge, skills, and access you need to invest like a pro. Today we're jumping in and we're tackling that topic of financial structure again, but today we're going to tackle it from a different way. We're going to actually talk a little bit about human capital, not through your process of realizing it, but what happens after you've already converted that human capital into resources for you to achieve your priorities. But as always, before we do that let's recap what's going on in the markets. We've recently, today in fact, global markets were shaken by fears over this Delta variant. Here in L.A. we got masks are back.
Brandon Averill (00:45):
So we'll see where all this turns, but hopefully we'll have some settling around here pretty soon. We got the Olympics coming around the corner, and for the first time ever zero spectators. This is going to have a huge impact financially on the Olympics. Anecdote, we heard that the last profitable one happened to be in L.A. back in the '80s, so it doesn't change that, but the magnitude of the loss could be great. Robinhood's seeking its $35 billion valuation. We've talked about Robinhood before, but pretty fascinating that their trading revenue, how they manipulate or go about their markets, actually really turning into real valuation here. Then something finally, not finally, we shouldn't bang on too hard, but Wells Fargo is the creator of the index fund folks, 50 years ago this month.
Brandon Averill (01:42):
So this is not a new phenomenon, although it seems like it oftentimes, but we do have Wells Fargo to credit for that, the index fund turning 50 this month. Then last but not least, end of the quarter, so we've got earnings seasons coming about. If you don't believe in that index fund, maybe you're the guy that's trying to figure out where the tea leaves are going, this is the time of year for you to kind of read where everything's going. But with that, we'll jump right in. Let's hit it on that financial structure, Justin. Really lead us. How does it change? Now that if you're moving from this time in your life where you're converting your human capital into resources, what happens after you get to that end and you don't have any more human capital coming in the future? Your financial structure's largely set. What are some of the things that we should be considering?
Justin Dyer (02:34):
Well, the short answer, there's still a lot to consider and there's a lot to control. But before we get into the nitty gritty there, I think it's good to take a quick step back. We've talked about financial structure. We've talked about human capital. We've mentioned priorities, and we have terms called protective reserve, essential spending, things like that that are somewhat internal here. But let's take a step back and define what we're talking about here. So on let's say the financial or the asset side of the ledger so to speak, you have your human capital. For people that are working, that are still playing, that are actively engaged in the company they've started, that human capital, that asset, is large. Then over time it gets converted into a financial asset or financial capital. You also have things that we categorize as personal capital or personal assets.
Justin Dyer (03:32):
Like think about your home, or some collectible, somewhat has a different meaning or value to you personally. It could be anything. That really summarizes the financial structure of your asset stack. Let's call it that. Then that's paired with your priorities or your spending needs. Those are unique to you, each and every one of us. And then how you categorize those and how we think about them is whether or not they are essential, or whether or not it's just a rainy day fund and you still have earnings coming in, and whether or not it's long term, right, or more discretionary in nature. And all of these different classifications affect how we then try and match your liability, your priority, with a certain financial asset or even human capital asset that would be converted into financial asset in the future.
Justin Dyer (04:35):
So that's what we're talking about really basically when we speak financial structure. I think it's good to just start there. And like we've talked about in the past, when you're playing, when you're still actively engaged in a company that you're running or you founded, that's your human capital at work. And you need to work towards harvesting that into financial capital and invest that in a prudent way to match your priorities. Right? We've said that a number of times, and it's always good repeating that. What happens, to Brandon your point, what happens when we realize all your human capital, or the vast majority of it, and it's sitting there, to be simple, sitting there in cash? How do you then think about it? Or it's sitting there in an invested market portfolio. Well to start with, we go back to the old adage, control what you can control. Right?
Justin Dyer (05:27):
So taxes, huge, hugely important in any phase of life, but definitely when your human capital, your financial capital, is largely in place. How do you minimize the taxes, the tax drag from your investments? Do you complete a Roth conversion? Do you do that each and every year? What's your charitable strategy? And I think it's also really important to understand, when that point happens, what generally is going on in a financial structure is your priorities are really becoming a reality. Not to say that you don't have priorities while you're still earning money and your human capital is still largely untapped or still being harvested. But when the human capital has been harvested and your financial capital is in place, the rubber kind of really meets the road.
Justin Dyer (06:25):
So that's an important distinction and I think where, Brandon, your conversations with clients probably really come into play. Where, "Hey, we've talked about X,Y,Z for 10, 20, years. Guess what? Now we get to do it." And then the importance of making sure that those priorities are matched with the proper asset so that you're able to realize it with very, very little risk. Which like we've talked about before we got on here, that where a lot of people generally go with portfolio construction is just using some mean variance optimization, or Monte Carlo, or something that's a little bit more reading the tea leaves as you said, or sticking your finger in the wind and figuring out which way it might be blowing today, and adapting your portfolio accordingly. It really puts your overall situation at risk.
Brandon Averill (07:21):
No, I think that's a great point, Justin, and we joked about it. Right? Monte Carlo is fun place to visit, but it certainly shouldn't be for your investment portfolio. Because for people that don't know that, the typical way that people go about planning for "retirement" or this period of time where your human capital has been realized is, "Okay, let's take a look at what you have. Let's take maybe a rough look at what you need, and then let's run it through these 10,000 different scenarios. That's a Monte Carlo for example, to show all the different sequence of events that could happen and what's your likelihood of your money running out or not running out, et cetera. The problem kind of becomes what happens if you happen to hit 10,002? You know? Like whoops, the COVID-
Justin Dyer (08:12):
What is that Mike Tyson quote?
Brandon Averill (08:12):
Yeah. Everybody has a plan until you get punched in the face. Justin Dyer (08:16):
Yeah.
Brandon Averill (08:17):
You know, I think that's exactly the point. What's a better strategy is doing like you said, Justin. It's really understanding the priorities and then matching the assets to the priorities. And I think you're hitting on that really important point, is your priorities change over time and they're hugely important to determining what you want to accomplish. But as you start to get closer to this period of time where human capital is realized, and we probably don't have too much more to help us in the future, we need to start to change our strategy. We need to change our priorities from priorities of, "Hey, let's make sure I've got this money set aside, this protective reserve, that if all hell breaks loose, and I need to protect my family for a period of time, I have this to rely upon so that way I can work things out and get back to work if I lost a job."
Brandon Averill (09:13):
Or your sport can continue if it's going through a COVID crisis, or a lockout, or all those different things. Those acute stress type scenarios to, "You know what? No, now I've got to protect my food, shelter, clothing, my essential priorities for the next 50 years, and so now that's my priority. My priority has shifted from a protective reserve of a couple years to really protecting my essential spending for the rest of my life." And that is unique to everybody. I think that was a great point, Justin, is that if you're not building out a customized plan for this period of time, you're likely not being very efficient. So if you're out there and you're like, "Well, I'm kind of moderate from a risk standpoint. I'm going to go 60-40 ..."
Brandon Averill (09:59):
Or I love the comment that we often get from people when we're talking to them, but it's like, "Well, if I can get 6% on my investment portfolio and pull four," it's like, well, you're assuming you're going to get 6% flatline for the rest of your life. I mean if you can find that, that's great, but that's just not the right way to go about the problem. It's really identify those priorities so that you can build your custom solution to your situation. Don't fit into somebody else's box, but really identify that.
Brandon Averill (10:31):
And then when you do, then it's all the tactics like you hit on, Justin. I mean hopefully you've been doing the non-deductible Roth conversions over time so you already have a nice Roth nest egg set up. But if not, we're taking that tax-deferred money maybe sitting in your employer 401k and now we're starting to look at the tax brackets. Can we convert small amounts of money every year to take advantage of tax brackets and reduce your tax burden over time? You know, all these tactics come in, but you really can't focus on the tactics until you really understand your priorities and how they change. That's an iterative process that we have to go through on a constant basis.
Justin Dyer (11:11):
Yeah, that's a perfect a phrase you use right there. It's a process. This isn't an event at all. If you're all of a sudden ready to say live off your financial capital, guess what, yeah maybe you've saved enough, you've earned enough, and you'll be okay. But you're missing out if you haven't thought through this in a thoughtful manner to really align your assets today, your structure today rather, not just your assets, with your priorities, both short-term and long-term. And to Brandon your point, where the short-term priorities, if you're playing, or you're still, again, working in your business, that's kind of the rainy day fund. That's to protect you for the one to two years where something comes out of left field and yet you're not earning anything. You need to retool. You need to come up with a new business idea. Whatever the case may be. Right?
Justin Dyer (12:08):
That's the current short-term protective reserve concept that we use. And then planning for, "Hey, you know what? I don't want to do this my whole life. In 10, 15, 20 years, depending on who the client may be, I want to hang it up completely. Or I want to earn a fraction of what I was earning prior to this date and time." Okay. Well, that's great. Planning ahead gives us the ability to implement the process, have this glide path to migrate from both harvesting your human capital, protecting you for this one-to-two-year period within this protective reserve framework, and migrating to this more 50-plus-year potential spending need, or priority need, whatever the case may be. In some cases we're talking about multi-generational wealth that's beyond 50 years, and really thinking through that and implementing these tactical tools that can truly be meaningful.
Justin Dyer (13:09):
Some people may think, "Oh, a Roth conversion. Well that's what, a few thousand dollars relatively speaking. Not worth it." Guess what? Peter Thiel, big venture capitalist, implemented a very similar strategy. He invested his Roth assets in Facebook, and he's sitting on a Roth account that's worth probably close to a billion dollars or billions of dollars. Now, total one-off there. Not saying that that's going to happen again. But if you think through these things and take advantage of these tactical tools that are available to everyone, quite frankly, you can really set yourself up for long-term success, multi-generational wealth, optimizing your overall net worth. You know, as we say, that's the goal here.
Brandon Averill (13:56):
I think that's a great way to say it Justin. I think at the end of the day, we've talked about this ad nauseam, but we'll continue to hit on it probably forever because it's true. Your financial structure just matters far, far more than maybe the individual investments that you're choosing in the long run, and so certainly making sure you're focused on this. If you're just randomly picking stocks ... I mean I talked to a guy today. He's up 126% over the last year. The S&P is up over a hundred, so is that really that much better? But what was fascinating is talking to him. There's zero tax efficiency to it. He's getting close to retirement. He has all of his money tied up in his 401(k).
Brandon Averill (14:36):
He's never thought about getting money into a Roth. He has no diversity there. So anything that he's gained in extra maybe from that, from his attention to trying to do things that probably are quite frankly luck, he's missed out completely on structuring his entire situation with the "return" that is available to everybody just from planning. You know, it's not risk-free, but it's certainly darn close to it. So I think at the end of the day making sure that you're continually focused on your financial structure, understanding the tactics that are available to you, controlling what you actually can control, is the way. And at the end of the day, don't forget your priorities are always changing.
Brandon Averill (15:21):
You need to keep those front and center, and your strategy should change to those priorities, because financial structure should be and is customized to you and your priorities. It shouldn't be anybody else's priorities. It shouldn't be some fit-in-a-box 60-40 allocation, et cetera. It really does need to be a good understanding between you and your advisors what your priorities are, how to build the best portfolio for that. With that, we're going to close it out here. As always, head over to awminsights.com. You can download our 10 Key Principles to Investing Like a Pro. Drop us a note. Let us know what you want to hear from us on future episodes. Of course, we appreciate your attention. And until next time, own your wealth, make an impact, and always be a pro.