Your Biggest Financial Asset Is You. And That May Put Your Portfolio At Risk.
You may think of your chosen career as something completely separate from your investing strategy. But according to David Blanchett, the head of retirement research at Morningstar Investment Management, your profession should play a bigger role in your investment decisions, and not just as a measure of future income. By ignoring the connection, you may be taking on more risk than you should—especially these days.
In economists’ terms, the value of an individual’s skills and talents is called “human capital,” a field pioneered by Gary Becker, a Nobel-prize winning professor at the University of Chicago who died last month. Becker’s models of human capital became the underpinning for the generally-accepted rule that young people should invest in stocks since they are still building human capital, while those in retirement who have “depleted” their human capital should have a more conservative asset allocation (although that theory is now being challenged by financial adviser Michael Kitces, among others.)
Blanchett believes that we need to go one step further and look more specifically at which industry workers are in to measure the inherent risk of an individual’s human capital. At the recent Morningstar Investment Conference in Chicago, he unveiled model portfolios for different professions (my nominal profession, journalism, wasn’t one of them, although “manufacturing” might work as a proxy—more on that later.)
How exactly do you measure the risk of human capital? Blanchett and his co-author Philip Straehl started with an equation for the variability of its return created by Roger Ibbotson. They then plugged in industry-specific wage growth rates, along with a bunch of other factors, such as the yield on the corporate bond index, for each industry to measure its relative health. (“We assume that the certainty with which the average worker within an industry gets paid a salary is the same as the certainty, priced into the bond market, with which the average company represented in the corporate bond index is able to meet its coupon and/or principal payments,” the authors explain.)
Blanchett and Strael then examined at the correlations between industry-specific human capital and the returns of 13 different asset classes. Some of the connections were intuitive—construction and real-estate had the highest correlation to REITs and high-yield bonds, while utilities had the lowest correlation to large and small growth stocks.
For investors, there are obvious implications: You should reduce your exposure to the asset classes with which your industry is already highly correlated, and increase your exposure to those with low correlation. “It’s sort of an extension of the rule that you should not hold a large amount of your own company’s stock in your portfolio,” explains Blanchett. “People tend to want to “buy what they know,” so someone who works in the tech industry buys tech stocks. I would recommend against this, with the exception of a small 'play' portfolio.” The same applies for health care, real estate, finance, etc., so it makes sense to prune your portfolio of specific stocks that are too closely tied to how you get your paycheck.
At a portfolio level, try to think of your profession as an asset class. In some examples Blanchett cited, if you’re a tenured professor, your job is more bond-like—low-risk but low-return—but if you work for a hedge fund, your job is more stock-like, so allocate accordingly.
When I later asked Blanchett what journalism was akin to, he responded, “Journalism would be an interesting case study. Our initial analysis is based on historical risk/correlations so I don’t think it would capture the risk of journalism today. I’m pretty sure both manufacturing and journalism are not likely to grow at the same rate as other occupations, so that’s a different risk that’s included in our model, and definitely complicates the issue.”
The fact that Blanchett and others are now looking at occupations to build portfolios points to a larger trend, which is that since 2008 human capital in general has gotten riskier across almost all professions. “In the past, a tenured professor was probably 100% bond-like, but today it might be more like 80% bond-like and 20% stock-like,” notes Blanchett. In today's disruptive economy, stable jobs may not remain that way. Your human capital may need replenishing in the future, just like any other asset.
Ruth Davis Konigsberg, a fortysomething journalist and consultant to Arden Asset Management, writes weekly about retirement planning.