How does lifecycle asset allocation work for individual investors?

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AcadiFi · Accepted Answer

Lifecycle asset allocation adjusts the equity/fixed-income mix across the investor's life based on the changing ratio of human capital (present value of future labor income) to financial capital (present value of investable assets). Young professionals hold mostly human capital, which for many occupations behaves like a bond (stable salary), so their total wealth is already bond-heavy and financial capital should tilt toward equities. As they age, human capital is consumed and converted to financial capital, so the financial-capital allocation should shift toward bonds to maintain a consistent total-wealth risk profile. Example: a 30-year-old teacher with $60K salary, 35 years to retirement, and $40K in savings has roughly $1.1M of human capital (discounted) versus $40K financial — total wealth is 97% bond-like human capital. Recommended financial allocation: 90% equities. At 55, with $500K saved and only 10 years of salary left (~$500K human capital), total wealth is 50/50; financial capital should be closer to 40/60. Tilts within the glidepath consider occupation-specific correlations: a bank trader's income correlates with equity markets, so their human capital is equity-like; they should hold more financial-capital bonds even when young. Life insurance hedges human capital mortality risk. Savings rate and target retirement consumption drive the absolute level of financial capital. Practical tools: target-date fund glidepaths, Monte Carlo with stochastic wages, and Milevsky's human-capital framework.

How does lifecycle asset allocation work for individual investors?

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