For most advisors, helping clients tally their net worth and determine their prospects for retirement is a fairly straightforward exercise. But getting them to quantify their “human capital” isn’t, says Moshe Milevsky, a finance professor at Toronto’s York University, in his paper, Lifetime Financial Advice: Human Capital, Life Insurance and Asset Allocation.

In fact, the most significant portion of clients’ net worth may not be what they can pull together in terms of stocks, bonds or real estate but the amount of money that they’ll produce over their working life, Milevsky maintains. This human capital means viewing and valuing employment as another asset and portfolio component.

Through study, training and experience, clients increase their earning potential, boosting the value of their human capital at the same time. As they mature and have fewer earning years ahead of them, human capital starts to shrink, however. Ideally, though, their financial capital is increasing at an accelerating rate as they turn earnings into assets.

And it’s the relative stability of that human capital — whether it’s more “stock-like” or “bond-like”— that should influence both the asset mix and the type of securities clients select as they move through life, says Milevsky, who has expanded on this theme in his recently released book, Are You a Stock or a Bond? Create Your Own Pension Plan for a Secure Financial Future (Pearson Education, 2008).

For instance, if clients have a job in a volatile sector in which their earnings fluctuate sharply, then their human capital needs to be viewed as a stock. As a result, they should probably consider investing a larger portion of their net worth in bonds or other lower-risk investments — even though the returns may be more modest.

If their job is secure and their earnings steady, however, then their human capital looks more like a bond and they should consider investing much more in stocks to take full advantage of the security they already enjoy.

This connection between job security and retirement savings is a key factor in retirement planning, says Jason Seligman, a professor at the University of Georgia. In a study entitled Asynchronous Risk: Unemployment, Equity Markets and Retirement Savings, he and colleague Jeffrey Wenger examined the relationship between retirement savings and unemployment to see if being jobless also causes people to miss out on investment opportunities that might boost their retirement savings.

The financial market leads the labour market, so layoffs tend to occur when stocks are at their peak. As stock values fall, individuals who might like to buy in and take advantage of lower prices simply don’t have the necessary income to participate, Seligman says.

Employees can expect to be laid off two or three times during their working lives, and these interruptions can have a dramatic impact on lifetime earnings — especially when the layoffs occur early in a career. Seligman suggests that most workers can expect to lose 8%-13% of their potential retirement savings because of unemployment. As well, as women are more likely to drop out of the workforce temporarily to care for children and sick parents, they may be hit even harder. Their erratic labour-force participation — and the fact that when they do work, they generally earn only about 80% of what men earn — means they are often at greater risk of a retirement shortfall, he says.

The problem today is that more and more people don’t have a defined-benefit pension plan, nor do they have all that much job security, Milevsky adds. All of which makes many of them resemble a stock. The challenge for advisors, of course, is helping this group build up sufficient assets soon enough if they’re going to end up investing money in low-yielding guaranteed options.

Clients who are civil servants or teachers, on the other hand, should generally have a heavier tilt towards stocks as they can expect to enjoy substantial indexed pensions at a fairly early age and tend to have pretty good job security.

Many people’s careers aren’t so clear-cut, though, which is where good judgment comes in. But, overall, the idea of varying the stock/bond mix in portfolios based on clients’ future earnings potential is another important variable in retirement planning. IE