Jonathan Clements’s June 14, 2014 Wall Street Journal article “How to Calculate Your Net Worth” is an excellent discussion of integrating human capital into your portfolio. Here are some of his main points. The bolded labels are mine, the rest is his:
1. Human Capital is a Big Part of Your Portfolio. If you’re under age 50 and gainfully employed, your most valuable asset is probably your human capital—your ability to pull in a paycheck. The Census Bureau estimates, based on a 2011 survey, that a college graduate who works full time for 40 years might have lifetime earnings of $2.4 million, while someone with a professional degree, such as a doctor or lawyer, might earn $4.2 million.
2. Insure Your Human Capital with Life Insurance. Your human capital should heavily influence how you handle your larger financial life. For instance, to protect your human capital, you likely need health, disability and life insurance. Suppose you go under the proverbial bus or, alternatively, go under the bus but survive. In either situation, the right insurance can help your family cope.
3. Borrowing Against Your Human Capital Can Make Sense. Early in your adult life, you might take on a heap of debt, including student loans, car loans and mortgages. Reckless? Arguably, it’s rational. By borrowing, you can purchase items you can’t currently afford, thus smoothing out your consumption over your lifetime. With any luck, you will have years of paychecks ahead of you, so you can service these debts and eventually retire debt-free.
4. For Some, Human Capital is a Relatively Safe Asset That Can Be Balanced Out With Aggressive Investment in Risky Assets. Your human capital is also the rationale behind investing heavily in stocks when you’re younger. Think of your regular paycheck as akin to receiving interest from a bond. To diversify your big human capital “bond,” you might devote your portfolio mostly to stocks. But as you approach retirement and your last paycheck, you should shift maybe half your portfolio into bonds, so you have investment income to replace the lost income from your human capital.
In the rest of the article, he talks about how (a) you might have some human capital even after you have “retired” if you don’t retire completely, (b) integrating social security wealth (the value of the future social security payments you will get) into your portfolio and © liabilities like everything you will need to spend on a kid.
Let me also flag Jason Zweig’s nice article the day before “Can You Handle the Market’s Stress Test?” about how to fight “loss aversion”–being very risk averse toward relatively small risks. Here is what I tweeted about it:
How to fight loss aversion: avoid nonfinancial stress and make sure to net out gains and losses against each other.