Author: Brent Lemieux CPA
Are you a stock or a bond?
What I mean by this is how certain are your future earnings (a.k.a. your human capital)? If you are an entrepreneur, working for or running a company with an uncertain future, or a freelancer/contractor, with large swings in earnings year to year, we would say you are more like a stock. Likewise, if you are in a steady job with a somewhat predefined path, you are more like a bond.
If you are more like a stock…
If your future earnings are less certain, it may be prudent to take less risk with your financial portfolio. Many of the riskier jobs I’m talking about are highly correlated to the economy and the market. When things are going well in the economy, you may be doing really well. This is a perfect time to increase your savings and invest a greater portion of your assets in high quality bonds. This will leave you better protected if your earnings fall or you lose your job in a recession. Imagine how horrible it would be if you lost your job and had to draw on your investment portfolio while the market was down severely? Honest reflection on the riskiness of your career could help prevent this scenario.
If you are more like a bond…
Now let’s say you are more like a bond and have a steady income in a career that is less susceptible to market and economic downturns. If this sounds like your situation you may be able to take more risk with your financial portfolio. Taking greater risk, if done strategically, should allow you to earn a greater return over time. Since your income stream is secure, it is unlikely you will need to rely on your investment portfolio to cover living expenses while you are still working. Because of this, your portfolio will have more time to recover from temporary market downswings before you retire and begin withdrawing these assets to cover living expenses. It is important to keep in mind that short term assets (money you will need in the next 5 years) should be held in cash or high quality bonds, no matter how certain your future income is.
A careful evaluation of your own situation will help you make more informed portfolio decisions, protect you against market swings, and optimize your retirement. If you have questions about how your human capital should be factored into your financial plan, please reach out to us!
Please Note: This is not the only factor that determines what your risk tolerance is. To fully understand your risk tolerance you should work with a financial planner.
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