The first time I heard the term “Labor Capital” clearly explained was in our monthly column by Larry Swedroe. So what is labor capital? Basically, it’s your ability to generate income by trading your labor for money. Larry advises that investors should take their labor capital into consideration when deciding their asset allocation percentages.
One of the most common investing pitfalls is investing a significant amount in your own company. You shouldn’t do this is because 100% of your labor capital is already invested in it. If you invest a significant amount in your own company, you risk losing both your job and your investment at the same time — i.e., Enron.
Sure you could cite Microsoft, Google, and eBay as a counter-point to the above argument, but remember that for every Microsoft there are hundred (if not thousand) of companies that failed. However, this shouldn’t stop you from taking a calculated risk if you are in the right place at the right time.
The same concept applies to domestic versus international asset allocation. People who have significant amount of labor capital in their locality should leverage international investment to spread out the risk.
For example, if your job is affected by a poor economy, your globally diversified investment should help soften the blow to your financial well being.
Lastly, the concept of labor capital explains why a younger investor could take greater risk with his investment portfolio. Since his investment is a small portion relative to his income, he could take on more risk and invest in more aggressive investment vehicles. This allows his investment to grow at the maximum potential, and any loss could be offset by adding more money to the investment.
As the investment grows in proportion to the investor’s income level, he should limit the loss by seeking less risky investment vehicles.
So, there you have it. Three investing concepts that could be explained by labor capital.
This post was featured in the Festival of Stock #85 hosted by Can I Get Rich On A Salary.