I’m a microcap growth stock. What are you?

Posted by Mike in 401k Rollover, rollover
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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.

Like Cliffs Notes…for Investing

If you’re looking for a brief, plain-English introduction to investing, I’d encourage you to pick up a copy of my book: Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less.