It’s become popular recently to think of your human capital (that is, the present value of all of your future earnings) as if it were an investment in your portfolio. For example:
- The human capital of a tenured professor is akin to a bond–it’s fairly steady, unlikely to vary significantly or disappear in any given year.
- I’d be a micro-cap growth stock–my income fluctuates a lot, and those fluctuations have a lot to do with how the overall economy is doing.
- My wife, an employee of a non-profit funded primarily by the state of Illinois, would be an Illinois muni bond (with the unfortunate difference that her income is subject to Federal income tax).
Human Capital and Asset Allocation
The purpose of characterizing your human capital as an investment is to take it into account when determining your asset allocation. For example, because of the high-risk nature of my own human capital, my wife and I keep a large portion of our net worth in cash.
In contrast, if your own human capital is akin to an enormous, high-grade bond holding, you can probably afford to take on more risk in your portfolio than I can.
Human Capital and Age
If you’re in your twenties or thirties, your human capital is likely more valuable than all your other assets combined. As you get older, however, the value of your human capital decreases (because you have fewer working years ahead of you), and the value of your other assets increases (hopefully).
Because
- human capital decreases as you age, and
- most investors’ human capital most closely resembles a bond
…it makes sense for most investors to shift their portfolios toward bonds as they age.
What to Look Out For
As helpful as it can be to consider the characteristics of your human capital when determining the rest of your asset allocation, it’s worth noting that this isn’t a precise science in any way. As we’ve seen over the last couple years, it’s surprisingly difficult to estimate the level of risk involved in one’s job.
Hi. I'm Mike Piper, the author of this blog. I'm 
Great concept, Mike!!! This makes a lot of sense and helps people visualize their TOTAL asset allocation a bit better. I’ll be putting this in my round-up on Friday.
I’ll go with “securitized junk bond.”
This is a great concept. We are our own most productive and valuable asset. I supposed I would call myself a preferred share – a stable, (almost) guaranteed minimum return with some upside for capital appreciation.
I’m a micro cap growth stock with an open HELOC at a nice low interest rate as a cash reserve.
Hmm… my friends would probably say I’m a dotcom stock. Lots of promise and endless ideas but where’s the money?
That’s mainly because they don’t have an insight into my investment portfolio, which underwrites the risks I take like you with my income.
I expect the latter to come back hard in the next 12 months (touch wood!) which would make me more of commodity extracting market cash cow?
You can probably go too deep down this rabbit hole! π
Incidentally, I always thought you had a very large amount of your money in stocks, rather than cash, for some reason. (Is it that what you haven’t got in cash, is all in the stock market?)
“You can probably go too deep down this rabbit hole! ;)”
Haha. Yep! π
“(Is it that what you havenβt got in cash, is all in the stock market?)”
Yeah, pretty much. I’m generally in favor of high stock allocations for lengthy time horizons–provided the investor isn’t made uncomfortable by the volatility. I just recognize that in my own situation, a big chunk of our money could very possibly have a short time horizon (in the case of a business failure or my wife getting laid off).
I think it’s interesting to think about how career should affect asset allocation, but unlike Milevsky et al, I think it really only comes into play at the margins: You’re a stock broker (tilt to bonds), or you have a benefit plan that is heavily invested in company stock or options that you can’t sell (short the stock to hedge job risk). Otherwise, I think the analysis can lead one astray. A friend is a tenured professor whose department just got vaporized. I’m a solo attorney, but I believe in Fama-French; should I avoid tilting S/V because it overweights me to business & consumer services and because I’m “a microcap stock?” I don’t think so, but instead endeavor to have a larger emergency fund.
Best regards,
Anthony
Thanks for the clarification. To clarify my comment, I meant to say the former will come back hard – my income.
Reading back my comment, it sounded like I meant my portfolio!
I’m not so greedy as to not be satisfied with a 60% in a year rally in equities, nor insane enough to expect the same this year! π
I love this post.
I consider myself a low cap growth stock, not because of my job nessesarily (I’m in an entry level salaried position) but because of my age (23) and attitude -big hopes and dreams. I’m still ‘low cap’ though as I still need to prove to the market my worth π
lol, okay so my human capital is decreasing? Good to know!