Smith is the financial adivro to Johnson. Johsnon is 35 years old with a STABLE and secure annual income of 175 000.
THey ask what allocation to invest in. I understand that this is Human capital that is bond like that is not correlated with the market index and therefor invest in a higher proportion of Equity over Bonds.
But the answer has 100% Equity and 0% bond as the allocation. That seems extreme. I figured it would be 80/20 at max and I actually went with 65-35 for E and FI.
Question with regards to human capital and financial wealth stuff.
The more financial wealth we have the less insurance we need all else equal
The more financial wealth we have and the Human capital is bond like à more conservative the portfolio for the individual à More insurance required
The more financial wealth we have and the Human capital is Stock like à more aggressive the portfolio for the individual à Less insurance required
So is the below correct?
If we have low financial wealth and human capital is stock like à we would have a conservative portfolio(Invest the low financial capital we have in BONDS) and more insurance then?
65-35% doesn’t make sense for a 35 years old investor with bond-like income. Say you work for the government, fully guaranteed job and you are young. Why would you invest 60-40% life the common 40-50 years old guy?
Life insurance would be useful for high-HC as it protects the valuable PV of future salary income.
I would have to read the question to be 100% sure of my answer. However, logically, investing 100% in equities could actually make sense if you get 200k a year, no debt, low liquidity needs, and have a fully secured job. Again, it’s more about how you justify your answer in the essay section. I doubt you would be awarded 0/3 for going with 80-20 and fully explaining your rationale. Cheers
The PV value of his human capital will vastly outweigh the value of his current financial wealth at his age and salary characteristics - bind like income that is discounted at a low rate (that is the asumption).
With this assumption made, he invests what little finanical capital he has to try to bring his overall portfolio more inline with an invester of his age and time horizon etc.
If he has financial capital of say 200,000 laying around, and the PV of his human capital is around 2,000,000 then he already has a 2m investment in what is in essence a “bond like” investment - so by investing his financial portfolio (of 200,000) 100% in equities, he still only holds just under 10% in equities when you consider his total wealth (human and financial).