The traditional approach to portfolio design involves diversifying the portfolio with low-correlation investments to help maximize the portfolio’s return for a given level of risk (or alternatively to minimize risk for a given level of return).
Yet from the holistic financial planning perspective, the reality is that the portfolio – or more generally, an investor’s “financial capital” – is only one asset on the household/personal balance sheet. And for accumulators who are still working, it’s not even the biggest asset, often trumped by the individual’s human capital that may be 2X, 5X, or 10X the value of his/her financial capital!
The significance of this distinction is that to truly maximize the risk/return characteristics of an individual’s total balance sheet, and all types of capital, it’s crucial to not just view the portfolio on a standalone basis, but to invest the portfolio to diversify around the often-much-larger human capital instead. Which means workers in conservative “bond-like” jobs might have even more equity-heavy portfolios, while those in more aggressive “stock-like” jobs should invest even more conservatively!
And even for those who are otherwise comfortable with their overall level of risk and equity exposure, arguably the future of designing portfolios for accumulators in particular – where human capital is really the dominant asset – is that the asset class and sector exposures of the portfolio should be adjusted around the risk/return characteristics of the worker’s job. For instance, those who work in the tech industry might really want to own less of the Technology sector in their portfolio! And ironically, the approach is especially relevant for financial advisors themselves, who are inherently so exposed to the economic and stock market cycle by virtue of their job, that they should own less in stocks themselves… or at least, far less in Financials!