Hedge yourself, not just your investment portfolio.
March 9th, 2010 | Published in Insurance, Life, Managing Wealth
A recent article from Paul Sullivan a dedicated reporter covering high-net-worth investors for New York Times, discussed about the importance of looking at hedging the Human Capital of the client, not just the Investment Portfolio.
Learning How to Hedge Yourself, and Not Just Your Portfolio
The idea of hedging a person’s future potential income is not new. This is the sole basis of insurance. In the earlier days, insurance companies have been championing this, though their more recent focus have unfortunately became advertising and enticing customers with promotions.
Here are some thought provoking ideas in the piece.
The thought of human capital has become more pronounced with the financial crisis. With nearly 10 percent of Americans unemployed and investment portfolios in losses, the value of work is given new importance.
The concept of human capital is used to calculate how much a client should be insured for. The higher the income, the more insurance cover needed. The longer expected years of working, the more insurance cover needed. Refreshingly, the more stable the income, the more insurance cover client should get. And vise versa.
How does the nature of your job affect your financial well-being? People have learned in this crisis that human capital is much more sensitive to the financial markets than they thought.
The key is to ensure your human capital and financial capital are not correlated. For example, if your salary as a tenured professor is not susceptible to fluctuations, you can take on more risk in your investment portfolio. If you are a investment banker with a large part of income coming from bonus and assets in bank stocks options. This, obviously, is what you want to avoid: the perfect correlation between human and financial capital.
For people with employee stock option plans, this may be worth a thought.
A more detailed and secure strategy will be to exclude specific risk of your work from your investment portfolio. Human capital of a real estate developer will not only be linked to real estate and also to the mortgage interest rates. Excluding additional real estate and credit market risk from the developer’s portfolio would be smart, but to go further will be to short an exchange-traded fund focused on real estate.