An alternative thought to personal investing

As an individual we have two sources to create/expand net worth.  This can be accomplished by either financial capital or human capital.  Financial Capital is based off of monetary worth (savings and investments), and it has an inverse relationship with human capital. Human capital is defined as the value of future earnings.  As you get closer to retirement , the number of working years decreases and human capital declines. On the other hand, financial capital should be growing assuming you are consistently saving.  Financial capital compounds at your portfolio's rate of return, while human capital compounds at your salary growth rate.  Coming into the work place a majority of a person's possible net worth will be based on human capital, as their financial capital will be small in most cases. As time goes on and savings amount increases, financial capital capital starts to grow while human capital decreases.  But, what does this has to do with investing? The answer is everything!

One of the pillars of good portfolio management is managing risk.  For example, if a person has a steady job with a known annual growth rate their human capital is considered pretty safe. This characteristic mimics a bond (fixed income investment).  What this allows a person to do is expose themselves to more risk within their portfolios by holding more equities or less liquid investments.  The individual is able to bear more investment risk since their employment status and financial viability is known.  On the other hand, if a person is in a position/industry that is going through a downturn, being unemployed is a higher probability.  With more employment risk the human capital acts similar to a stock (equity investment).  To balance out this risk, it would be prudent for a person to move into more conservative investments to preserve capital.  When considering your situation cash flow is dependent on your employment situation.  This is not a new concept and is tactically used by institutional investors all the time.

When investing(and saving), most people fail to account for the total risk that they are taking by not factoring in their occupation.  In essence, a person could be exposing themselves to more risk, or capable of bearing additional risk.  One point that should be emphasized is that if your future value is derived primarily from your human capital, the two primary ways to increase that amount are by increasing your salary or increasing your savings rate.