Hi all,
At the very end of SS8, Schweser mentions that individuals at young ages have a very high HC, but low FC. So far so good.
Then, they mention that because of that fact, the individual will have a considerable bond allocation, while “the FC should be allocated toward riskier assets like equities”.
From what I understand the HC is just the PV of future income earned through employment, correct? So, that’s not real cash in the current period. How could that future income be allocated today then if it “doesn’t even exist” yet?
Thanks
It’s not actually allocated in anything, but that PV is theoretically viewed as an investment with bond-like characteristics, thus FC should be weighted heavier to equities. It should be noted however that some HC can have equity-like characteristics (a private client financial advisor for example who’s compensation is somewhat linked to the performance of the equity markets), and in this case, FC should be allocated more conservatively.
It’s similar to looking at future pension or Social Security income. It may not even be a current cash flow, but it has a PV, and thus should be considered when developing a long term asset allocation. Future sources of fixed income allow an individual to take more risk with their financial assets.
Thanks a lot, great explanation.