Your Human Capital

As you design your portfolio, don’t just focus on your time horizon. If you are still in the workforce, also give some thought to how many paychecks lie ahead and what sort of job you have. To that end, you might think about your human capital—your income-earning ability—in three different ways.

First, you might view the paychecks you receive as similar to interest collected from a bond. During your initial decades in the workforce, you might diversify your human capital “bond” by investing heavily in stocks. But as you approach retirement, you’ll want to move perhaps half your portfolio into bonds to replace the paycheck you’re about to give up.

Second, while you are working, your paycheck provides you with a way to cover the bills. Result: You’re freed up to invest largely or entirely in stocks and there’s less need to own conservative investments, such as bonds and money market funds. Instead, such conservative investments are more crucial for retirees, because they can be sold at short notice to generate spending money without fear that their price will be deeply depressed—a perennial concern with stocks.

Third, you might view the paychecks you’ll collect between now and retirement as a source of future savings. Think of those future savings as cash that’s yet to be invested. If you add that future cash to the conservative investments you already hold, you will find your portfolio’s split between stocks and more conservative investments is less aggressive than your current holdings suggest. But with the arrival of retirement, you’ll have no more future cash to be invested—and you will likely want to compensate by allocating more of your portfolio to bonds, money market funds and similar investments.

The above discussion assumes that, during your working years, you’ll receive paychecks with clocklike predictability. But will you? Much depends on the nature of your job. If you’re a university professor with tenure, you can be highly confident you will receive your future paychecks. But if you’re a contract worker or a commission salesperson whose income can vary sharply from month to month, your income is far less certain—and your human capital looks more like a stock than a bond. To compensate for that uncertainty, you might tilt your portfolio more toward bonds, even if your time horizon suggests you can be more aggressive.

As you settle on an investment mix, also think about the industry where you work. Often, realtors own rental real estate, Silicon Valley employees dabble in technology stocks and doctors buy shares in pharmaceutical companies. These folks may think they have an edge because of their intimate knowledge of their own business. But from a risk perspective, they’re effectively doubling down, betting both their paycheck and their portfolio on the same sector of the economy. The most egregious example: employees who invest heavily in their own employer’s stock. But if the company gets into financial trouble, they could end up both out of work and holding a fistful of worthless shares.

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