Wednesday, July 29, 2009

Implementing 'personal balance sheet' key to diversified retirement portfolio

Moshe Milevsky urges advisers to add human capital to the equation
Investment News
By Mark Bruno April 5, 2009, 6:01 AM EST
Financial advisers need to begin re-evaluating traditional portfolio construction techniques, and they can start by measuring an individual's "human capital" if they want to create truly diversified retirement portfolios for their clients.
Admittedly, it is an abstract concept for many advisers, said Moshe Milevsky, associate professor of finance at York University in Toronto, …
Only after this value is ascertained will advisers have a complete picture of a client's potential assets and liabilities, "and then they can start considering ways to allocate their financial capital and meet their long-term liabilities," he said. …
[Jeffrey Gitterman, founder and chief executive of Gitterman & Associates LLC, a financial planning firm in Woodbridge, N.J., and the author of "Beyond Success: Redefining the Meaning of Prosperity" (Amacom Books, 2009)] noted that by calculating a client's human capital, an adviser can clearly show an individual just how much of his or her total capital is directly aligned with his or her job.
"If the next 30 years of your income could come from one company, in one specific sector, you have to start thinking about ways to hedge against that," he said. "That's the only way to really be diversified."
Moshe Milevsky: Advisers need to put more emphasis on clients' current and future earning power.Photo by
Moshe Milevsky: Advisers need to put more emphasis on clients' current and future earning power.
Mr. Milevsky pointed to the examples of firms in the financial services sector that have either disappeared altogether or declined significantly in value during the last year. Many of the executives and rank-and-filers at these companies had significant portions of their personal wealth tied to their firms — wealth that has now essentially vanished.
In such a case, when a client is in a particularly volatile line of work and his or her net worth is concentrated in that industry, advisers should suggest that they place the vast majority of their tangible assets in stable investment vehicles, such as fixed income. …
Their actual assets, or financial capital, should be used to balance out any of the risks to their human capital, he said. This strategy is designed to generate consistent and somewhat predictable returns.
At the same time, a client in a steady profession with little career risk — a teacher, for example — has "bond-like human capital," Mr. Milevsky said. He suggested that this client's assets be invested entirely in equities, at least at first.
"Over time, our human capital decreases and we're forced to rely more on our financial capital as a result," Mr. Milevsky said "That must be accounted for early on in the process."
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  1. The personal balance sheet is the most powerful personal finance tool I can think of...

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