Human Capital, allocation to the Risk Free Asset

[ryzhiy]

Hi boys and girls,
Could please someone comment the following for me? The snippet comes from the CFAI R14, answer to the question #3.
“For a typical investor whose human capital is less risky than the risky asset, the optimal asset allocation is more conservative the more financial assets the investor has”.
This is in relation to a 35 year old phyisican (stable salary, low risk), who has just inhereted 1M USD.
Should not it be vice versa?

• Long time horizon
• High asset base
• Low risk salary income

All these factors say that he can assume a lot more risk, not less.
Thanks!

 

[Rofh]

It is kind of subjective. A large asset base (financial assets) means more conservative investment. in order to balance human capital and financial capital Given that he is 35 and human capital is still a huge portion (stable salary and uncorrelated with stock market) he should invest more in equities.
Of the factors that you mention above, high asset base will suggest less exposure to equities because you have to balance human capital with financial capital. The more financial capital you have the less exposure to equities you will have. Think it that way.
This is when thinking about the relationship between human capital and your financial capital. For an IPS the larger your asset base the more ability you have to take risk.

 

[ryzhiy]

I think I’m getting it. The thing is that his HC is not risk free like, but bond like, which means a risky asset, but less risky than equities. If we consider asset allocation between risky (Bonds + Equities) vs risk free, he already has a bunch(huge amount) of risky capital, thus his inhereted wealth should go to the risk free asset in order to balance the portfolio.