As an individual enters the accumulation phase, their human capital is more equity-like and therefore they should invest more in fixed income. At the same time, from risk profiles in the IPS, younger investors are more risk tolerant and can invest in equity more. Don’t these ideas contradict each other? Any help would be appreciated!
no contradiction . The younger you are the more equity you should invest in . Accumulation is when you’re in a stable position in life implying you’re older . Those folk need to go to fixed income as time passes by.
Yes, I noticed some contradictions here in the curriculum.
In one area it says HC is equity like and should be offset with bonds. In another area, it says younger individuals should take high equity risk in their securities portfolio (even though their HC is also high & equity like).
The key here is to evaluate risk tolerance, then evaluate level of FC vs. HC, then make a reccomendation to what securities to allocate to.
It is certainly not cut and dried.
the type of HC is the key driver for asset allocation, given the total portfolio perspective (inclusive of HC and FC) in focus. equity like HC (volatile, correlated to financial markets) would want to diversify this as much as possible by offsetting it with bonds in FC. for a young individual, and i’d even argue one in the accumulation phase depending on the level of equity-likeness in the HC, the could require offsetting it almost completely with bonds to create a well diversfied portoflio, especially given the dominace of HC in younger investors
I asked schweser this question. See below for the email:
“Hello, In the human capital chapter of private wealth managament, it states that younger investors entering the accumulation phase have human capital that is equity like, so more of their financial assets should be allocated to bonds (LOS 14g). In LOS 21o of asset allocation, it states that the younger investor should allocate more to equities (which makes snese to me), because human capital is more bond like. How do we reocncile the difference?Thanks”
“That’s a tough question since they contradict each other. I would say based on the 2011exam which had a question like this with the person being young and unemployed although their past job was unstable and equity like. The answer was that she should allocate more towards bonds because of her young age which correlates with SS4. Regards,”
Not sure I fully agree, but what can you do
Blows my mind that the CFA has been doing this for 50 years & can’t clear up contradictions like this in the curriculum, or at least provide reasonable / logical guidance.
Also, seeing some of the guidline answers in the old morning tests really makes me think less of them.
And it makes me wonder what kind of crazy explanations they had for some of the more off the wall Level 2 questions.
what page is this in the curric?
I have learnt that the optimal allocation should consider Total allocation = FC + HC
If investor is young ------his HC is more than the FC------he should invest more in equity out of FC.
Lets say that HC (more stable job- something like professor) - 5 Mil & FC (at this stage) = 1 Mil. His Target Allocation is 70:30, Equity: Bond. Even if he allocate whole of his FC in to equities…his effective allocation would be ( 1 / 6 = 16.67% equity & 83.3 Bonds ) would still be quite different than target. In later stage of his life, there comes a point when FC would be greater than HC. Here he would start shifting his FC towards bonds…
Now , the exception is if investor is doing a job related to equity market (any job which has a high correlation with Equity market . i…e if equity market is on bullish mode—investor is getting good sal, high growth propects)…Here he would be allocating more into bonds. Whole idea is to minimize the correlation btn FC & HC.
Thanks for your input. I guess this is weird one and perhaps looking at total HC and FC is the way to go. I so much prefer it when it’s clear cut…
I remember this question. I believe the individual was employed by an equity management firm and their compensation was based on the equity markets. In this case, it was a trick question where the individual’s income was correlated to equity.
Generally, human capital can be thought of as a fixed income allocation as an individual’s paycheck pays off like a bond coupon.
There is no contradiction here.