Risk Capacity over the Life Cycle: The Role of Human Capital, High Priority Goals, and Discretionary Wealth

Abstract

From the perspective of wealth management, life cycle theoretical models suggest that the total portfolio, including human capital, should play an influential role in determining the composition of financial assets. In fact, by incorporating human capital into portfolio choice optimization, investors become wealthier, holding a respectable amount of safe assets. Young investors should be invested in stocks, and the risky asset share is expected to decline as individuals convert their human wealth into financial capital. Unfortunately, these academic recommendations and popular wisdom are inconsistent with the empirical observations on portfolio choice at an international level. In this article, stylized facts on income and saving patterns over the life cycle are presented, providing evidence that human wealth should be hump-shaped; younger workers, who do not have substantial wealth, have to implement a hierarchy of saving goals. Discretionary wealth to invest aggressively in the stock markets is present only during the years of middle-aged prosperity. The glide path used by the actual target-date funds in retirement plans needs to be reconsidered. <b>TOPICS:</b>Retirement, portfolio construction