-The question of Human Capital
The article by Nanette Byrnes considers an important question relating to everyone’s financial lives (Byrnes, 2010, p. 1). The question is, can people be stock like or bond like in their characteristics. The article points out these characteristics as the age of the person, job type that a person has, whether this job can be affected by volatility in the stock markets etc. Hence the issue being inspected is ‘Diversification’ in investment. While considering where to invest; wealth management gurus stress the need to diversify. Traditionally, this exercise includes allocating resources to different asset classes. But Ibbotson associates took this approach a step further, to include ‘human capital’ into the equation (Ibbotson, 2010, p.19).This approach discusses who are the bond like people and who are more like stocks. There is a further classification to the categorisation (eg if you are a bond, are you a junk bond or a treasury). This categorization depends on how safe is you job as compared to the ecomony’s overall health. If you work in a industry, that is stable as such, and there are no possibilities of you getting fired (hence you are a bond with regular cash flows); but your company’s revenues might dip in case of a meltdown. This might lead to downsizing and ultimately loss of job. In such cases you might be categorized as a ‘junk bond’. On the other hand, you might be working on Wall Street (in which case you will a stock). But your job might be at a senior level, or you might be irreplaceable. In such a case, though you are a stock, you will be categorized as a ‘Blue Chip’ stock, as you might not loose your job outright. At most you mmight take a pay cut in very adverse market situation.
The data that has been used to reach the conclusions, include the demographic data, job type data, income expected at various stages in life. This data is then plotted on a graph to create a pictorial representation of total wealth of an individual over a lifecycle, with optimal asset allocation. This ‘optimal asset allocation’ can be made, only if ‘human capital’ is brought into the picture and considered as one of the investments. The portfolio of an individual can thus be truly diversified if he considers himself as an investment too.
The findings of the study include the identification of who is a bond and which people are more like stocks. The Bond people include a. The young people b. People who are in stable jobs. The young have a lot of time to earn a stable wage, and thus tend to be like bonds. And people in jobs that do not get affected by market volatility are bonds too. People whose jobs can be lost because of economic turmoil or stock market crashes are the Stocks. But there are a lot of people between these extremes. Milevsky thus suggests that we consider our own ‘Beta’ or sensitivity to stock market. The role of insurance as a hedge to savings not yet earned is also highlighted.
According to me, the thought of considering our human investment as an asset class makes a lot of sense. The human capital and all the effort we put in our work is a very important investment. Suppose for a moment that I am a tech entrepreneur. I have invested my talent, skill and time to my tech company. This is an important part of my portfolio. Now, since I already have exposure to teach, while allocating my savings, I would like to avoid tech companies and would rather invest in other industries to diversify my investments. As is the case with industry, so it is with asset classes. Since I am a new entrepreneur, my venture might fail or my fortunes can skyrocket overnight. Thus, it is like a stock investment. Thus, while making my other investments, I should consider bonds for safety.
The article has introduced me to new jargon and concepts like:
Human Capital: It is the skills, knowledge, and experience that is possessed by an individual considered as their value or cost to a particular organization or a country. (Investopedia, 2004)
Aggressive investments: These are the investments where the investor takes relatively high risk to gain a higher return. Among asset classes that are considered aggressive are stocks, but even within stocks, there might be sub classifications. For example, a blue chip stock is relatively safer as compared to a small companies stock.
Works Cited
Aggressive Investment Strategy Definition | Investopedia. (2003). Retrieved March 29, 2016, from http://www.investopedia.com/terms/a/aggressiveinvestmentstrategy.asp
Byrnes, N. (2010). Are you a stock or a bond? Retrieved March 20, 2016, from http://blogs.reuters.com/reuters-wealth/2010/12/15/are-you-a-stock-or-a-bond/
Human Capital Definition | Investopedia. (2004). Retrieved March 20, 2016, from http://www.investopedia.com/terms/h/humancapital.asp
Ibbotson R. G. (2010). The importance of asset allocation. Financial Analysts Journal, Volume 66 , Number 2, 18-20
