Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance

Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance

Roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, CFA, and Kevin X. Zhe (2007)

Introduction

We can generally categorize a person’s life into three financial stages. The first stage is the growing up and getting educated stage. The second stage is the working part of a person’s life, and the final stage is retirement. This monograph focuses on the working and the retirement stages of a person’s life because these are the two stages when an individual is part of the economy and an investor. Even though this monograph is not really about the growing up and getting educated stage, this is a critical stage for everyone. The education and skills that we build over this first stage of our lives not only determine who we are but also provide us with a capacity to earn income or wages for the remainder of our lives. This earning power we call “human capital,” and we define it as the present value of the anticipated earnings over one’s remaining lifetime. The evidence is strong that the amount of education one receives is highly correlated with the present value of earning power. Education can be thought of as an investment in human capital. One focus of this monograph is on how human capital interacts with financial capital. Understanding this interaction helps us to create, manage, protect, bequest, and especially, appropriately consume our financial resources over our lifetimes. In particular, we propose ways to optimally manage our stock, bond, and so on, asset allocations with various types of insurance products. Along the way, we provide models that potentially enable individuals to customize their financial decision making to their own special circumstances.