I’m a little confused on how to answer certain questions regarding asset allocation of financial capital when given a description of an individuals human capital.
The general point of the CFAI readings is that if human capital is “stocklike”, especially if the individual is younger and has a lot of human capital, his or her asset allocations should be tilted towards the risk free asset.
The end of chapter questions seem to conflict each other. The answer to EOC question 2 regarding Wu recommends a 65% allocation to risky assets and the answer to EOC question 3 regarding Lee recommends an 80% allocation to risky assets. I understand that they have risk tolerance, and time to make up for a few years of poor returns, but this seems to conflict with the general teachings.
And then question 6 asks about a 23 year old stockbroker and all of a sudden it recommends bonds as an investment? If you’re going to recommend a 65% and an 80% allocation to stocks to Wu and Lee in questions 2 & 3, why would you recommend bonds to Tom in question 6?
Human capital tends to be more like fixed income (salaried employees get the same amount of pay every pay period like a coupon payment from a bond). If they have substantial human capital that is fixed income-like, and they are young, and can tolerate the risk, their financial capital should be allocated to mostly equity.
Human capital can be more equity-like (i.e. entrepreneurs, commission-only sales people, etc.), and they don’t know when or how much their next paycheck will be. In this instance, they need to have their financial capital allocated more towards fixed income.
Yea, that makes sense. Why then would CFAI make the recommendations they do for Wu’s portfolio on EOC question 2 and Lee’s portfolio on EOC question 3?
Both of those individuals have human capital that is described as more equity-like, yet CFAI recommends allocations of 65% and 80% to risky assets for their respective portfolios.
EOC question 6 asks which investment Depuy is likely to recommend to Tom, a 23 year old stockbroker. The answer is a bond. But wouldn’t an advisor still be likely to recommend predominately stocks given his age?
Even in Figure 11 which has optimal asset allocation to the risk free asset for a 45 year old, the high end of the range for proportion to the risk free asset is only 20% despite a 0.90 correlation between labor income and risky asset returns.
Why wouldn’t a stock still be the appropriate recommendation for Tom?
The question6 is just asking u to consider that he is a stockbroker…so his income would be equity like…is.human capital would be equity like…so he needs to increase fixed income investments like bonds in his investments…which would be advised by inv manager… I think for eoc 2and 3. answer can vary a little bit in exam…but reason should be correct…as we are not suppose to remember graphs…