Bruce's Blog: Wiener Financial Management

News & Notes

Are You a Stock or a Bond?

 

What is the largest component of your total wealth? Your brokerage account? Your retirement account? For many people, the biggest part of their wealth lies in their ability to earn income in the future.

Human capital is the present value of your future labor income. Some people's jobs are like a bond. A tenured professor can reasonably rely on a fairly steady stream of income over time. Other jobs are more speculative, like stocks. Working at a high tech start-up may lead to a large pay-off, but the business could just as easily go bust.

When considering investment decisions, almost all of the analysis focuses on financial assets, while human capital is typically ignored. Those advocating the inclusion of human capital in the asset allocation process suggest that if your job is like a bond, then you can invest more heavily in stocks. Conversely, those who lack a stable income may wish to employ a less aggressive approach with their investment portfolio and tilt more towards bonds.

While this concept makes sense, it may be psychologically difficult to implement. As Christine Benz of Morningstar points out, a sharp decline in the stock market can often cause much concern. The fact that someone's employment may be like a bond does not necessarily make that person feel any better when his stock-heavy portfolio drops. The theory may not keep pace with emotions.

The financial advisor Michael Kitces believes that the concept of human capital has implications beyond the allocation of financial assets. According to Kitces, if human capital is indeed a major component of wealth, than efforts to increase your income is very important. For someone in their 20's and 30's, increasing the growth rate on their human capital by 1%, with compounding of that growth over time, has a radically greater impact than increasing the return on their investments by 1%.

In the end, the biggest concern is to avoid putting all your financial assets and human capital into one basket. Many employees at the now defunct Enron and WorldCom had a large chunk of their retirement accounts in company stock. The failure to diversify meant that when their companies went out of business, the employees lost their jobs and their retirement savings.

Words of Wisdom

I used to work in a fire hydrant factory. You couldn't park anywhere near the place.
-- Steven Wright

News & Notes

The Importance of Beneficiary Designations

Once upon a time, William Kennedy married Liv Kennedy.  They divorced. In a divorce decree, Liv waived her rights to William's retirement plan benefits.  Liv eventually died. Yet, when William subsequently died, his retirement plan did not pass to his daughter per his will, but instead went to Liv's estate. 

The U.S. Supreme Court granted William's late, ex-wife's estate the loot for a simple reason -- William had signed a plan document stating that Liv (his wife at the time) was the beneficiary of his retirement account.  William never amended this beneficiary designation and it controlled the disposition of the money.  William's will and the divorce consent decree did not override it.

The moral of the story is straightforward:  Make sure your beneficiary designations are current and accurate.  This is true for all sorts of designations, including life insurance policies.  Please consult an attorney for advice regarding these matters.

There is a caveat, for the more legally inclined.  As Ed Slott, CPA and IRA expert, notes: "In footnote 10 of the case, the court did leave open the option that after the funds were distributed to the ex-spouse, there could be a case against her to recover the funds based on the divorce decree."  But for planning purposes, you do not want to rely on this to enforce your wishes.

See: Kennedy v. Plan Administrator for Dupont Savings and Investment Plan (2009).

Words of Wisdom

"Being of sound mind, I spent it all."  [A will being read by a lawyer to the decedent's family.]
-- Classic Cartoon