Swedroe: Factor Human Capital Into Your Financial Plans

March 20, 2017

  • Households do adjust their portfolio holdings when switching jobs, consistent with the idea that households hedge their human capital risk in the stock market.
  • The effect, which is highly statistically significant, is especially strong for job changes that lead to large changes in wage volatility: A household that experiences an increase in wage volatility of 20% decreases its portfolio share of risky assets by 20%.
  • A household going from the industry with the least variable wage to the industry with the most variable wage (all else equal) decreases its share of risky assets by up to 35%, corresponding to the workers’ hedging demand for aggregate labor capital risk.
  • These findings are consistent with prior research, which found evidence that households that expect high future wage volatility hold relatively low shares of risky assets.

The authors also found that an increase in net worth leads to a significant decrease in the allocation to risky assets. This too is logical, as increases in net worth lead to reductions in the need to take risk. In addition, while more wealth is always better than less, the marginal utility of wealth declines as wealth increases (at some point you determine you have enough, and it’s not worth the risk to try to create more). The study illustrates the Swedish investors acting rationally, putting portfolio theory to work.

Further Evidence

Sebastien Betermier, Laurent Calvet and Paolo Sodini contributed to the literature on human capital and investments with their study, “Who Are the Value and Growth Investors?”, which appears in the February 2017 issue of The Journal of Finance. Their paper investigated value and growth investing among Swedish residents over the period 1999 through 2007. Among their findings were that:

  • Households are not heavily tilted toward stocks in their employment sector, with the average direct stockholder allocating 16% of the stock portfolio to professionally close companies.
  • Value investors are substantially older, are more likely to be female, have higher financial and real estate wealth, and have lower leverage, income risk and human capital than average growth investors—those with high human capital and high exposure to macroeconomic risk, who tilt their portfolios away from value.
  • Over the life cycle, households progressively shift from growth to value as they become older and their balance sheets improve, with 60% of the increasing exposure to value explained by changes in age, 20% by changes in the balance sheet and 20% by changes in human capital.
  • Households with high financial wealth, low debt and low background risk tend to invest their financial wealth aggressively in risky assets and select risky portfolios with a value tilt.
  • Households with high current income and high human capital tilt their financial portfolios toward growth stocks. So do those with high income volatility and a self-employed or unemployed head of household. Further, households working in cyclical sectors tend to reduce their portfolio value tilts.


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