R17, Q15 textbook

[difanchen]

Hi guys,
A Q here from the textbook. I am not really following the logic and wasn’t able to find any basis to think with right out the textbook.
The client already have a target asset allocation; but the answer deviates from it greatly with at age 30, 100% investment in stocks.
Can someone please help and explain the logic behind it?

 

[mfrasc]

Hi, the target asset allocation for total wealth (total wealth = financial capital + human capital) is 60% stocks and 40% bonds. Human capital is said to be risk free and uncorrelated with stock returns (so like bonds). At age 30, human capital = 2,100,000 and financial capital = 100,000. The question is asking: Determine Smith’s optimal asset allocation for stocks and bonds in his financial portfolio at age 30. Since at age 30 the vast majority of his wealth is in human capital (bonds), then all of his financial capital has to be in stocks and even that doesn’t even come close to reaching his 60% stocks and 40% bonds target asset allocation.
If you need more information on Human Capital, I would suggest to review Reading 12, which discusses Human Capital.
Good luck