The answer to Schweser reading 31, concept checker 7 says: The allocation of 85% of the portfolio to risky financial capital would imply the investor’s human capital is rather high…Brian is probably a young professional with a high-income potential, little need for current income, a long time horizon and fairly low current wealth.
Per the information, if human capital is high and the individual is a young professional with a high-income potential, wouldn’t you want to invest more in risk-free, not risky as this investor has done?
An additional consideration is whether or not his income is bond-like or equity like, that would help determine the allocaiton to equity or fixed income.
Also recall that the PV of HC is higher when you are younger (after completing your education and starting to earn money) and your FC is lower. As you get older this changes as the PV of your HC starts to decrease and your FC starts to increase So if you have high human capital, you have more time to recuperate losses.
If the income is equity-like (i.e. a sales-commission job that results in volatile earnings), then you should invest in fixed-income (better safe than sorry). If your income is fixed-income like (nice, quiet government job, cubicle etc. and doesnt fluctuate much) then your income stream is quite stable so you can afford to invest in equities (you can take more risk).
^ age seemed to dwarf the impact of income characteristic, if I recall the EOCs from that reading correctly. there was a question that compared a young stock broker (equity type income), and a young finance professor (fixed salary type income), and the answer for both was still majority equity, though I think the proportion was slightly higher for the prof… i forget
You are right, I recall a similar EOC answer explanation. The portfolio for the young stock broker should be expected to be more weighted towards fixed income securities and the finance professor more towards equity securities - just for the purposes of this concept and this explanation.
The question doesn’t have any commentary on whether income is equity or fixed income like. It only has the below table: Cash and equivalents 5%
LT treasury bonds 5%
Domestic corporate bonds 5%
Domestic equities 50%
International equities 20%
Real estate 15% Per the answer, if human capital is high and the individual is a young professional with a high-income potential, I would have thought we would invest more in risk-free, not risky?
My two cents, because his HC is high, high income potential and very long time horizon, this implies he has above average risk tolerance (than an older person with lower HC and shorter time horizon). Therefore its reasonable to invest in risky asset than risk free.