Makin' Money

Gen-X and risk

Chris Farrell May 20, 2011

Risk matters when it comes to investing. Our guest blogger builds on that key insight. Moshe A. Milevsky is a finance and mathematics professor at York University and the author of the book: “Are You a Stock or a Bond?” He lives in Toronto, and blogs from airplanes, hotels and conference centers.

Moshe Milevsky: Financial commentators are wringing their hands in despair over the recently released data “proving” that Gen X isn’t embracing the cult of stocks, and equity-based funds, to the same extent their boomer parents did a decade or two ago. If this trend isn’t reversed soon – worry the financial industry executives who actually make their living packaging stocks to the public – Gen X and their overly conservative portfolios will never reach the critical money mass needed to finance a long retirement.

“What can we do to get these kids into the stock market?” They all ask.

But, in actual fact, Gen X shunning equity is perfectly logical and consistent with a branch of economic theory that has re-emerged, re-popularized under the name of Human Capital Asset Allocation.

Human Capital – i.e. the importance of education, skills and training — has long been recognized as the key to a higher standard of living for society and individuals. Everyone agrees that investing in human capital is good, and pays dividends over time. That was version 1.0 and is the mother’s milk of global economic development.

The basic premise of the theory of Human Capital version 2.0, is: (1.) Your job and ability to work is actually an asset, and likely the most valuable asset on your personal balance sheet. You should think of yourself as a gold mine or an oil well, which over the next 30 to 40 years of your working life will generate cash flows. It has an ascertainable value today. Price it.

More importantly, (2.) some jobs are secure and guaranteed, like predictable coupons on safe bond, and other jobs are fickle and sensitive to the ups and down of the economy. In other words, your human capital has risk characteristics not unlike a mutual fund.

Finally, (3.) your financial capital, which is a fancy name for your investment and retirement savings, should be allocated based on the safety or riskiness of your job. Human capital and financial capital should balance and counteract each other. To put it bluntly, if one is safe, the other should be risky and vice versa.

Now – back to Gen X — let’s take a very careful look at their human capital’s risk characteristics. First of all, they have less job security compared to their parents. Those who do have found steady and reliable employment are much less likely to have a defined benefit (DB) pension, compared to the baby boomers. They also have much more student loan debt. Alas, for many of them their human capital is quite risky, and sensitive to the vagaries of the economy and its proxy the stock market. So, it should come as no surprise that their financial capital – the little bit of savings they have managed to accumulate — is tilted towards more safe, conservative assets.

So, for those who want to “nudge” Gen X into stocks, I say give them some long-term career security and convert their job into bonds – first.

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