When we last left off, I mentioned that asset allocation decisions could be affected by what you do for a living. I’ll explain:
The theory goes that if your income stream is stable, you might be able to take some greater risk in your portfolio, but if your job status is less predictable, you should err on the side of conservatism. Consider two examples:
A career military officer is typically going to have a steady income stream during his or her working years, as well as in retirement through a defined benefit pension plan. If this job were an investment, you might think it sounded a lot like a bond. Assuming the government maintains its practice of adjusting future income for inflation, then it would share some of the same aspects as a bond with an inflation protection feature. Teachers, firefighters and perhaps some private sector employees with similar benefits are in a similar category.
The second example is close to home for me. Let’s say you work in the finance sector, where your annual income fluctuates with the stock market. You tend to make more money when the stock market is rising and less money when it is falling, and in a bear market, you might have some risk of losing your job. In this case, your job sounds more like a stock than a bond – and maybe even a highly volatile stock!
So, how do you factor job security into your asset allocation decision? Well, in the first example, our Lt. Col. in her forties could consider a higher allocation to stocks, knowing that her job and pension are expected to provide a stable income stream. And in the second example, yours truly should probably have a higher allocation to bonds (which I do) knowing that future employment income will be more volatile than in other industries.
Think about your own job (including industry and future career plans) – is it more like a stock or a bond? You might want to nudge your asset allocation a bit in one direction or the other depending on the answer.