This whole human capital / financial capital nonsense...

Schweser Book 1 Page 356 Professor’s Note: “As the individual’s financial wealth increases, the portfolio should be allocated more and more toward lower risk investments.”

why is this? because human capital is low so less risk should be taken in the financial capital allocation?

financial capital is highly correlated with equity markets in most instances

to remain diviersified, as your financial wealth increases, you should increase allocation to fixed income


The idea is if you work in a high risk job like equities trader or something, your human capital (your future salary) is high risk and correlated with the stock market

So, if you put all the money you have already earned = your financial capital, into the stock market, and the stock market goes to hell.

You can lose those savings + lose your job at the same time.

Hence, to diversify, the guy above should invest the money he already made into safe, secure securities.

Now, this is how the theory goes. But realistically, try telling some young hot shot finance kid of 25 to skip out on equities and invest in 10 yr Treasuries and he’ll laugh in your face and call you a moron.

If you have a lot of human capital and very little financial , generally allocate to equities ( i.e. take risks with stock). Ability to take risk in stocks more , need to grow the assets more

If you have less of human capital ( and hopefully more of financial ) , take less risks with equities ( i.e. with stock ) . Ability to take risks lower and need to grow the assets less

In the Finnegan case in the 2011AM exam, she has high human capital (young, expects to work soon), yet the answer (to part C i believe) says that she needs to decrease equity allocation.

This is the Q that tripped me up.

she has 70% in equities already, remember

and she is highly correlated job as well.

The guideline is slightly misleading the way it is worded , but the answer is right . Her career going to be in Finance and investment , so her job will be correlated with equities , so reduce .

Do not over think , unless you have some point . keep it Short and Stupid

In this question, her financial advisor says to reduce the equity allocation at this time, and then question asks reason to reduce Finnegan’s equity allocation.

Couldn’t the reasoning be that she has no job (technically HC =0) and so she needs to play it safe, hence reduce the equity allocation. would this be a fair way to say?

Volume 3, Page 342 #14: As discussed in the reading as well, because of the important of human capital in relation to financial capital during youth, for many investors equity investments will be very large relative to fixed income holdings.

I guess they mean that many young investors have equity investments dominate their financial capital, althought they theoretically shouldn’t.

“Finnegan’s compensation was highly correlated with equity market returns and she expects this will be true from the rest of her working life.”

High human capital that is correlated to equity, so reduce equity in financial capital.