Factoring Your Job into Asset Allocation

by Ritu Agrawal · 8 comments

If you have ever received advice on investing your money, chances are you’ve had the benefits of diversification drilled into your brain. “Diversify and rule” was my college economics professor’s one-line strategy for managing his retirement portfolio. Corny but true. The virtues of diversifying your investments have been borne out by mathematics, finance and plain old personal experience.

While you may be diligently diversifying away your risk by investing in stocks, bonds and super-safe CDs, there is a good chance that you are forgetting to include the most important asset you own: You! Or more specifically, your future earnings potential, the big bucks you can (and hopefully will) generate in the future.

The nature of your career greatly affects your ability to take on risk and should be a major factor in deciding the mix of investments that will work for you. For example, consider my economics professor. He was in his early 40s and tenured which meant his job security was pretty ironclad. While we did detect a trace of bitterness in his anecdotes about ex-colleagues who left to take up lucrative consulting gigs, his salary and perks were definitely more stable and predictable. And yet, he was a big believer in bonds, loving their steady, dependable trickle of coupon payments. If you pretend that the stream of his future paychecks is an actual investable asset, he was overly invested in steady, fixed-income bonds. His portfolio would have benefited from taking on the risk of the more volatile returns of the stock market, thereby diversifying his dependable but not-so-lucrative wages.

On the other hand, consider someone who is also in their early 40s and employed as a software consultant to major IT companies. While she makes a good amount of income from her programming projects, the flow of work is unreliable. Projects dry up when the economy is not doing well, and during boom times her phone rings off the hook with client requests. The stream of the software consultant’s future earnings is rather volatile and correlated to economic conditions, just like stock prices, and her portfolio would be well-served by being weighted towards steady, fixed income assets such as bonds.

Bottom line, diversify your paycheck with your portfolio. If your paychecks flow like the stock market, with happy highs and nasty lows, consider buying the protection of bonds. If your paychecks come in like clockwork but don’t get bumped up during economic boom times, consider weighting your portfolio towards stocks. Always consider the whole picture of your finances when deciding where to put your money.

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{ 8 comments… read them below or add one }

Miranda October 26, 2009 at 5:48 am

So often we forget to consider what we do as a career as one of our assets. But it really is an important consideration.

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MoneyNing October 26, 2009 at 9:37 am

Considering that our job is the number one funding source of our savings and the fact that savings is the most reliable and controllable aspect of wealth creation, I would argue that it’s one of the most, if not the most important consideration asset when it comes to personal finance.

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Daniel @ Sweating The Big Stuff October 26, 2009 at 7:30 am

I only recently realized that your job is part of asset allocation. When tlaking to my father about his work and his savings, at first it seemed that he wasn’t doing enough to protect himself. He seemed unworried that he might lose his source of income. I quickly realized why: there was little to no chance of that happening. If anything, he had started working privately 2 days a week, so he would still have something to fall back on, even in the most extreme case of emergency. So while he may not have the largest emergency fund, he is in a great position, and the “standard rules” don’t apply to him as much as they would to someone in a different profession.

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Ritu Agrawal October 26, 2009 at 9:15 am

Right, it helps to be realistic about your job both ways. There are many former investment bankers out there who started out with 6 figure salaries and enormous signing bonuses after graduation, but then saw their companies take a hit. Many lost their jobs. It’s easier said than done, but understanding the volatility of your industry is really very important.

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Jane October 26, 2009 at 9:44 am

Hi Ritu,
Great post.

I’d heard that spouses should have jobs in different fields to be diversified in case one field tanks. You put another twist in diversifying a person’s job with their investments. Thanks. Look forward to hearing more from you.

David: You have a knack for picking great guest contributors.. :-)

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Sally October 26, 2009 at 10:10 am

This is something I haven’t heard of but it makes so much sense. I have a pretty stable source of income, and I should be more aggressive with my investments.

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Financial Samurai October 26, 2009 at 11:38 am

This is a key topic Ritu, thnx for highlighting.

Everybody should do a discounted cash flow analysis, or future cash flow analysis on their income stream.

Being able to work and produce income is BY FAR our #1 asset.

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kenyantykoon October 26, 2009 at 11:47 pm

this makes sense. get some security brought by regular income. i think this is also important to people with a high risk tolerance but more so the conservative risk averse investor

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