Heard a surprising suggestion on Bloomberg’s Odd Lots that offered a new insight into the standard 60/40 portfolio. Let’s assume you have a secure job with a 100k salary. You could consider it like a 1mio bond with a 10% coupon, providing 100k of fixed income. Whether the traditional 40% bond allocation is the right thing is besides the point here. You already have a major part of your hypothetical portfolio in this asset class and can allocate all other wealth to stocks/ETFs.
Your pension fund might also be considered a bond as it provides annual returns with a lower limit of 1-2%.
Isn’t that at the core of life cycle investing? That when being young, you have a lot of human capital so should take on more risk with your portfolio and go on leverage and that when you are older, you have less human capital so that you should take less risk with your portfolio, with the aim of having a similar allocation during all of your lifetime if you take into account your human capital into it?
With regards to employment risk, I think one should assess the likelihood that they can keep their level of compensation for an extended period of time and use that to qualify just how safe that income is. People in sales with a huge part of their compensation linked to performance in cyclical industries may have to consider their income more stock-like while people with life tenure may consider it like very safe bonds.
edit: see @Wolverine post below Using the perspective that the salary is like fixed income from a hypothetical bond, it becomes binary: 100% stocks while employed, less while retired.
There will be RAV unemployment money for up to 2 years, allowing for a gradual transition to more bond, if you need to reduce risk.
I don’t think it is. It’s more like a fixed term annuity. I don’t get the face value of my income generating job bond back when I retire. At that time, that value is zero as all of its worth will have been distributed through monthly incomes.
That means that the closer I am to retirement, the lower the value of the hypothetical bond that generates my income. In the mean time, the closer I am to retirement and the bigger the financial capital I am likely to have accrued that I can hold in stocks. Why should I have, say, 10% in stocks and 90% in a hypothetical bond when I start my career and then 90% in stocks and 10% in the hypothetical bond when I near the end?
There should still be a glide path. Sure, at first, we are overly too conservative considering our future income weighs so much more in our financial outlook vs the returns of our meager portfolio but it should switch somewhere down the path of our career.
Life cycle investing adds the notion of leverage, that because we have so much “safe” job income at the start of our career and so little wealth to put in stocks, we should go on leverage to lower that “bond” exposure and increase our stocks position. There again, as we become older, the amount of leverage should decrease to keep the allocation constant through time. Of course, leverage puts other risks into the picture and it becomes more accessible the more assets we have so that is not perfect at all but I think it builds on that concept that human capital is a bond-like return and should be factored in our target allocation.
Edit: the way I would factor it in my allocation is by using a discounted cashflows valuation method adding all my discounted future expected income and considering that total amount as fixed income for the purpose of computing my allocation.
Though interesting way of thinking your human capital, I don’t think it makes any practical sense.
The bond part of your portfolio is there mainly for reducing the volatility compared to a stock-only portfolio.
If you are not feeling comfortable now with 100% equity portfolio volatility I do not see how thinking of your human capital as a bond will change that.
And of course it is too simplistic to think it as bond. As others mentioned your are not eventually getting back the capital.
I think we need to differentiate between asset allocation and cash flow management.
Employment income is generating Cashflow it’s not an asset. If I need to sell 20% of my assets for some reason, I cannot ask my employer to give me salary in advance for future. Also when stock market crash, bonds go up. However this cannot be said for employment income. On the contrary, with stock market crash, employment also becomes more risky.
Personally I think only bonds are bonds. Everything else is something else - cash is cash, 2nd pillar is a high interest savings account and employment income is income.
Not sure about this article but I have seen a tendency with gurus to push for higher equity allocations and sugar coat it.
Cynical mode on:
Business making money with people investing their money suggest everyone that they should keep investing since everyone has an hypotetical huge Bond.
Pikachu face.
I violently (!) disagree with this principle. Your employment is perhaps the least stable/reliable thing in your life. Even people who haven’t lost there job ever (or for a long time) often don’t realize how close they may have been - e.g. I’ve seen good people, solid contributors, on a restructuring list on multiple occasions (without them knowing, without them in the end being kicked out) due to various circumstances.
I actually work along these lines: your AVS/IHV are really a bond secured by your working life.
But your coupons will vary according to your income but a certain amount is guaranteed. Ie 60-65% of your last income at worst, 80% if jobless. You supplement that with your investments. I live like that, it’s not always rosy (what with 3.5k/month with no subsidies whatsoever, IHV + Aussie military pension) but it is doable. Basically your IHV and 2nd are bonds on your life.
Live like a retiree, anything extra is just that: jam on bread and butter. Why is jam so expensive?
Also life can easily throw you a curveball and you may get a sickness preventing you to work or whatever.
I‘d view my own employment more like a stock that pays dividends, and that stock is also correlated to my employer‘s stock.
I think this is one of the areas where theoretical finance heavily clashes with real world finance.
On a population level employment is quite stable, as well as income levels etc.
On an infividual level? So much can happen.
I never liked the concept of human capital that much.
One reason I want to be FI as soon as possible is exactly that, I don‘t view my high income from work as anything very stable and secure, and it needs extreme effort for me to keep up and not get fired.
I like that idea. Notwithstanding my initial excitement about a not so good analogy, I can see AHV/IV to be the bond part of or lives.
With an annual fixed income of 12k - 24k it could be considered 500k of bonds with a 2.5%-5% coupon. I may be stretching the analogy again but I like the idea of this junk of hypothetical wealth sitting somewhere in a government treasury vault
Bro, you’re practising heavy frugalism. Isn’t this extra hard in an expensive place like Switzerland?
That government treasury vault is mostly the collective checking accounts of companies and taxpayers’ wallets. AHV/IV (mostly) isn’t prepaid but we levy taxes to pay for current expenses.
The difference is like saving, investing and living from withdrawals or spending our income without necessarily saving and going into debt if we can’t afford our expenses.
The difference is mostly philosophical while we have income/the economy provides for it but it’s like having influence because you have a lot of wealth (government treasury vault) vs having influence because of a valuable skillset (deriving/taking value from the strength of the economy).
Edit: there again, AHV/IV payments are more like an annuity than a bond. We can give them a value but that involves using actuarial tables rather that a straight % coupon on a principal.
By reading and partipating to this forum, you confirm you have read and agree with the disclaimer presented on http://www.mustachianpost.com/
En lisant et participant à ce forum, tu confirmes avoir lu et être d'accord avec l'avis de dégagement de responsabilité présenté sur http://www.mustachianpost.com/fr/
Durch das Lesen und die Teilnahme an diesem Forum bestätigst du, dass du den auf http://www.mustachianpost.com/de/ dargestellten Haftungsausschluss gelesen hast und damit einverstanden bist.
