What's Missing from Your Retirement Planning?

When estimating total net worth, most people add up the value of their tangible assets such as stocks, bonds and real estate and then subtract their debts. But there's an important element that often gets overlooked, especially when it comes to planning for retirement: human capital, which is another way of describing your earning power.

Most people don't view their portfolio in a way that includes human capital.That's not their fault, said Kevin Crain, head of Institutional Retirement and Benefit Services at Bank of America, because the statements from Social Security present your future financial situation in a very different way than your 401(k) or IRA statements. "A 401(k) statement typically does a great job of showing your balance, the funds invested in and returns," he said, "but they don't give you a good idea of what it means to you in terms of monthly income."

Social Security, on the other hand, provides statements that calculate how much you will receive every month at retirement age. But most people can't convert that monthly amount into a present lump sum and see how it factors into the asset allocation of their other investments.

Present salary, plus a future stream of income in the form of Social Security, should be considered the same as conservative investments in your total retirement portfolio, Crain said.

When viewed this way, you gain insight into two areas that help determine retirement readiness: how aggressive to be with investments in your retirement accounts and how long you'll need to keep working.

"We need to show the retirement picture in totality, not in disparate buckets," Crain said. Then people will be able to adjust their portfolio diversification as their earning power changes in the years leading to retirement - whether they decide they can semi-retire with a lower salary or keep working a few more years. They can also use their human capital as a sort of hedge in the portfolio.

For example, if you have a steady job in a relatively recession-proof industry such as health care, you have a higher probability of keeping your current stream of income and can take a few more risks to gain growth in your retirement account. But, if you work in a volatile industry like housing, you've likely become used to booms and bubbles and should plan your investments accordingly -- and perhaps more conservatively.

As you get closer to retirement, you can factor in the loss of your present salary and take into account other fixed-income sources, such as Social Security, to recalibrate your asset allocation.

The financial industry will get better at helping people with total planning, Crain said, and he's already seen that people contribute more and take a more active role when the process is made easier and somewhat automated. The next step for the financial industry, he said, is to find ways to wrap in the human capital factor and make that just as simple: "Most individuals don't think about this, not because they don't want to but because it's a massive responsibility."

The key is to present information in a meaningful way that provides solutions.