Labor Capital, The Forgotten Asset Class

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.

Why You Shouldn’t Invest In Your Company Stock

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.

Why You Should Invest Internationally

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.

Why Younger Investors Could Take More Risk

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.

9 Comments

Mrs. Micah
April 18, 2008, 8:49

After seeing how easy it was for one of my dad’s employers to simply drop 1/4 of their experienced employees…(of course their stock plummeted too) I didn’t want to have all my eggs in one basket. Fortunately, he didn’t.
Jones
April 19, 2008, 5:55

Well, investing in your companys stock may have some advantages too, for some of us. I just graduated from college and cant afford to invest anywhere else because there is a minimum amount to open an acct, usually 2k, while investing in your compaanys stock you can start with just $7.00, weekly contributions, plus, usually there is a discount (at least for the company i work for), no selling/buying commissions, and a few others??? So its not that bad after all???
Enginerd
April 19, 2008, 11:56

None of the headlines are actually questions, yet they have question marks: Why Younger Investors Could Take More Risk?
should just be
Why Younger Investors Could Take More Risk
or
Why Can Younger Investors Take More Risk?
Pinyo
April 19, 2008, 12:04

@Mrs. Micah – Always good to learn from others’ experience/mistakes.
@Jones – You just graduated from college so you could take more risk. If you could buy your company at a discount compare to the general market, then it might not be a bad buy. However, once your investment is a little bigger, I think the best bet is to diversify and build a balanced portfolio.
@Enginerd – Sorry, late night blogging.
Make Friends, Earn Money
April 19, 2008, 12:07

Your point about younger investors taking more risks is right on the button. I think that as you get older and closer to retirement you should be looking to consolidate investments into more secure streams, so as to minimise the impact of any negative downturn in stock markets. However there are some people who still like to take risks, i suppose it depends on your personality type.
Jones
April 20, 2008, 6:38

I didnt mention it in my earlier comment, but thats what im planning on doing, pretty much exactly what you responded. Since i can buy at a discount im already earning money that way… right? Once there is a large sum in that acct, ill sell those shares and buy shares of something else…
Pinyo
April 21, 2008, 17:44

@Make Friends – Absolutely.
@Jones – I think that’s a good plan. Since you’re buying at a discount, you’re getting a guarantee return — which is awesome. Just don’t get too caught up with the company stock, unless you really feel that the stock is going to take off.
I know that sounds like making a gamble, and it is — but you’re young and you can afford to take that type of risk.
Aaron Stroud
April 22, 2008, 21:48

Pinyo, I like how you clarify that younger investors can take on more risk. Too many people urge younger investors to assume more risk because they think increased stock risk always translates into higher returns given enough time.
These are the same people who also cheerfully point out that past performance is not indicative of future performance. That disclaimer applies to the stock market as well as individual stocks or mutual funds, but you wouldn’t know it from the way they talk.
Mike
April 23, 2008, 18:06

Jones does make a good point about investing in company stock. My wife got to buy stock at a 15% discount from her former employer. Many of the people there would buy the maximum allowed and sell it the same day. But otherwise, I agree with your point.
A related issue is that many companies have started making participation in their 401K plans the default choice as opposed to making employees opt in. This is great, in that it forces unmotivated workers to invest in their retirement, but the default investment choice is often heavy in company stock. Obviously that’s probably better than nothing, but it does setup workers for a double loss (job and retirement) if the company tanks.