Is Your Career a Stock or a Bond?
Provided by Paul Andrus
Stocks, bonds, and cash each have a different level of volatility. It’s important to know each investment’s risk profile so that you can diversify your portfolio with assets that form a spectrum of risk/reward scenarios. The same holds true for your human capital. Have you considered the risk profile of your human capital in your overall financial strategy?
Human Capital Defined
Human capital is the present value of expected future labor income; in other words, your earnings potential. You convert human capital into financial capital throughout your career by saving and investing some of your earnings in traditional investments such as stocks, bonds, real estate, and cash. These assets make up your financial capital, and, when combined with your human capital, give you a more complete picture of your total economic wealth.
Determining Your Human Capital Risk Profile
Like traditional assets, human capital also has a certain risk profile, ranging from stable and low-risk (bond-like), as in the case of a tenured university professor or government employee, to risky and volatile (stock-like), such as a commissions-based stockbroker, freelance consultant, or an entrepreneur.
Managing the Risk Profile of Your Total Economic Wealth
Just as you allocate your financial capital across investments with different risk profiles for diversification, you should also balance your human capital and financial capital so that your total economic wealth matches your overall risk tolerance. This means that, if you have a bond-like profession, you might consider investing your financial capital in slightly more aggressive traditional assets. Conversely, a stock-like career might allow for you to become a little more conservative with your assets.
Allocating Your Financial Capital to Meet Your Overall Risk Profile
Consider Bill, an investor who wants to properly allocate his assets according to his risk profile.1 Bill’s total economic wealth is $2,000,000, with $1,000,000 in financial capital and $1,000,000 in human capital. Because Bill has a stable career as a government employee, his human capital is similar to a conservative portfolio of 80% bonds and 20% stocks. Therefore, Bill’s $1,000,000 in human capital is comparable to $800,000 in bonds and $200,000 in stocks. To achieve the proper asset allocation for his total economic wealth, Bill must include the allocation of his human capital to determine the allocation of his financial capital.
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To learn how to incorporate your human capital’s risk profile into your total economic wealth, please contact your representative. NYLIFE Securities LLC is a wholly owned subsidiary of New York Life Insurance Company.
This concept is derived with permission from Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance, by Roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, and Kevin X. Zhu. 1 Hypothetical example intended for illustrative purposes only.