Despite the rapid development of economic theory, the life cycle product is still based on the theory of mean variance optimization. The key concepts of Harry Markowitz and William Sharpe still dominate lifecycle products. However, in order to adapt to the retirement needs of the new era, life cycle products need to consider human capital.
The concept of human capital
The introduction of the concept of human capital is important for lifecycle products. Unlike financial capital, human capital refers to the sum of factors such as knowledge, skills, and physical strength that exist in the human body. In the management of wealth in life, human capital is also defined as the present value of future work income.
Generally speaking, people who are new to the workplace have the highest human capital. On the contrary, financial assets are relatively low due to lack of savings and investment. However, with the increase of age, human capital will gradually transform into financial capital. In general, when you reach the age of 50, an upward trend financial capital exceeds the human capital in a downtrend.
Human capital theory believes that young people’s wealth is made up of human capital and can take on higher risks in financial products. The reason is that they have a long investment period and have time to recover the losses that may be caused by the investment. When the age is gradually increasing, the risk of financial products should gradually reduce in order to minimize the declining value of the account by the negative impact of market fluctuations. Therefore, through the life cycle products, the proportion of financial assets is dynamically allocated to meet people in different human capital cycles.
Stock or bond?
The characteristics of different jobs also affect the allocation of life cycle assets. If you are an entrepreneur or a company owner, your income style is more like stock. Conversely, if your income is primarily a monthly stable wage, your human capital is similar to a bond. In the allocation of financial assets, people with similar stock income should increase the allocation of bonds. Professionals with stable incomes, such as doctors and professors, should increase the allocation of stocks.
Age effect in human capital is obvious. However, the human capital of different occupations will also influence the risk of how to allocate life cycle products. For example, suppose that university professors and stockbrokers have the same human capital and financial capital, and both have the same risk tolerance. Which one should hold more stocks? Many people will think it should be stockbroker. After all, stockbrokers usually know stocks better than university professors. However, if we analyse the situation carefully, we will find that the human capital of stockbrokers is more relevant to the stock market. In order to achieve the risk of achieving the same wealth, stockbrokers should reduce financial capital to the stock market. Therefore, financial assets in the life cycle should be reduced in relation to human capital.
Human capital seems to have no relation with financial products, but it is closely related to financial planning. Investors can not ignore their own human capital and need to consider including human capital in their total wealth.