One of the big rules of investing is that what matters is our portfolio as a whole. We can cope with losses on one or two assets if they are offset by profits elsewhere, but perhaps not if they are accompanied by other losses. For many of us, however, one of our biggest assets – and for younger investors by far their biggest asset – is our human capital, our ability to earn a living. We should regard this as part of our portfolio of assets. And doing so overturns some conventional financial advice.
The first question to ask is: is my human capital like a bond or an equity? If your earnings are volatile and insecure it is an equity, but if they are stable it is a bond. And if you hold lots of bonds you can afford to take on more equity risk. Other things equal, therefore, doctors should hold more equities than architects.
Although this might seem obvious, it implies that one longstanding piece of financial advice is wrong – that young people should own more equities than older ones. This is because, generally speaking, younger people’s human capital is more volatile than older people. They are more uncertain about their future careers: they cannot truthfully answer that cliched question, 'where do you see yourself in five years’ time?' Such uncertainty is partly cyclical; in a boom it is youngsters’ whose career options improve the most and in a downturn it is theirs who suffer the most while those in settled careers are less vulnerable. Young people’s human capital is therefore more like an equity than older ones’. On this account they should own fewer equities than older folk. And they should increase their equity exposure as they age and as their human capital becomes more like a bond. This is the exact opposite of the idea that we should own fewer equities as we age.