Episode Transcript

Announcer  0:02
Welcome to the Biz Money Podcast hosted by Lee Korn. Lee is a financial advisor and principal at Opal Wealth Advisors. Each month Lee and his guests share their path of success and how they broke through to get to the next level. This podcast is available on our website at opalwealthadvisors.com/bizmoney. To receive updates on new show releases, you can subscribe on our podcast page. Now, here’s your host, Lee Korn.

Lee Korn  0:29
Welcome to the Biz Money Podcast. I’m your host Lee Korn. On behalf of my colleagues here at Opal Wealth Advisors, we’re excited that you’re able to join us.

Brian Nick  0:43
So human capital is basically the flip side of financial capital. It’s the earnings potential that you have as an individual that will eventually be converted into real earnings and those earnings will be deployed in all those asset classes you just mentioned could be stocks, bonds, real estate cash, but you haven’t made the money yet. So it’s basically your potential.

Lee Korn  1:01
Our guest today is Brian Nick, Chief Investment Strategist at Nuveen, a global investment firm with over $1 trillion in assets under management. Brian analyzes global economic and policy developments and their impact on financial markets. He is frequently cited in the financial press, including Bloomberg, Financial Times, Barron’s, and CNBC. Welcome, Brian.

Brian Nick  1:21
Thanks very much. Pleasure to be here.

Lee Korn  1:22
Awesome. So tonight, we’re going to talk about a topic human capital. Right? It’s not something you would typically expect to hear from a financial adviser or wealth manager, investment manager, but it’s important. You know, we typically talk with business owners often about how when you’re looking at your asset allocation, and you talk about stocks and bonds and cash and alternatives, how your business is part of your asset allocation, right. Highly illiquid, highly concentrated, but still stock nonetheless, yes. One area that we don’t talk often about is human capital. Right. And human capital, whether you’re a business owner, whether you’re a highly comped executive, whether you’re late in your career, early in your career, it has an impact on how you invest, right, really invest and psychologically how comfortable you are with investment. So I could ask you your thoughts, what exactly is human capital?

Brian Nick  2:21
So human capital is basically the flip side of financial capital. It’s the earnings potential that you have as an individual that will eventually be converted into real earnings. And those earnings will be deployed in all those asset classes you just mentioned—could be stocks, bonds, real estate, cash, but you haven’t made the money yet. So it’s basically your potential. Obviously, it’s hard to quantify in advance, you can’t know it in advance, but you can have a sense of estimating what it might be, depending on your field, depending on your level of experience, your level of education, it’s going to be different for each individual, but you have to take it into account. What is it? What is going to be my earning pattern? What is my likely trajectory of earnings over my lifetime over the balance of my career? And how do I balance that with the money I’ve already made that’s being invested currently?

Lee Korn  3:04
Right. So it sounds like when you’re thinking about making investment decisions, am I going to be more aggressive? I’m going to be more conservative, that would have a great impact. How have you seen over your career, different investors make decisions based on where they stand? I guess, like you said, when you’re looking at your human capital, probably the first day that you go to work, your human capital is the highest…

Brian Nick  3:25
It’s 100% of your assets, before you’ve made any money.

Lee Korn  3:28
Great. And usually when you start your first job, unless your trust fund, inherited a trust fund or come from a very wealthy family, usually your financial capital is at its lowest. So how have you seen that dynamic influence decisions with investors?

Brian Nick  3:45
So when I first started working, I had just bought an engagement ring for my now wife, then fiancé, so I was actually negative in financial capital, because I owed my parents a little bit of money, because it was a bit more than I thought it was gonna be. So my human capital was more than 100% of my financial assets. It’s an interesting discussion to have an investment because most people come to the sort of conservative, moderate aggressive conversation, thinking that it has a relation to age, which it does, but not because young people are inherently more risk loving, risk taking or older people become more conservative. It’s because of this human capital question. Because most people’s human capital looks a lot like a bond—fixed income, right, you get a paycheck every two weeks, or every month, or whatever it is. And that’s what most people get when they go to work. And that looks an awful lot like a bond, it grows over time, right? You advance in your career, you switch firms, maybe you get a higher compensation, but for the most part, it stays with that sort of predictable pattern. And that’s why when you’re young, whatever financial capital, you have amassed, whatever savings you have, you want that to go into a more aggressive portfolio, right? Not because you’re young and risk loving and aggressive. It’s because you want to have the money you already have made grow as fast as possible. And you do have some kind of resistance to losses on that, because you have a long timeframe before you’re gonna use it. But really, it’s because you’re over allocated to human capital. And that human capital looks more like fixed income as you advance throughout your career, you turn 65 years, so you’re gonna retire the day you turn 65. That means your human capital is basically drained down to zero, and you’ve made all the money you’re going to make. Well, that’s when over time hopefully, if you’ve been doing this, right, you’ve been converting some of that sort of equity money into more fixed income. So it replicates the income you were getting. During your career. Maybe you have an annuity, maybe you have a bond portfolio, whatever it is going to be. But you have to find a way to make up for that lack of human capital that you’ve been basically drawing down on your whole life.

Lee Korn  5:32
So it sounds that as you move through the different life stages, as you move from early on first getting your job to closer to retirement, your human capital draws down, right, so you’re reallocating. When your human capital goes down, you have a greater equity percentage, right? Because your human capital replicates a bond investment. And as you get closer to retirement, it flips.

Brian Nick  5:55
Yes, and hopefully that nest egg has been getting bigger too, right. So this is the idea behind things like target date funds or just the idea in your head, this glide path to retirement because you want to make sure you have not only a portfolio that is appropriately sort of geared towards volatility in markets, but also in a portfolio that is going to, again, replicate to some level of satisfaction, the income you’re getting, maybe at age 65, or on average from ages 25 to 65. And that’s why as your portfolio gets bigger, it will inherently become more conservative too, because you’re basically preparing for those next 30 years of your life in retirement, and trying to create as little of a speed bump as possible in terms of differences, you have to have an income and lifestyle, assuming your risk tolerance hasn’t changed very much.

Lee Korn  6:39
And it sounds like it’s not only age based, but it really has to do with the type of job that you have. Right. So if you are a tenured teacher, if you’re a nurse, if your job is very stable, your income is very stable, you work for a union, very different than, you know, working as a commissioned salesperson working in a field that there’s lots of job turnover. Yeah, I would imagine not just the age, but the type of job would have an impact on the decision of how you allocate your human capital into your overall portfolio.

Brian Nick  7:12
Absolutely. The more that your income, and you named a couple of professions right there that could even be on a schedule where you know, to a certainty, year one, this is how much I’ll make, year two, year three. And if you stay with that career, your entire working lifetime, you can really model this out in advance, and you know exactly what you’re going to be getting. And you probably have an idea of what you’ll be putting into a retirement plan as well. And so how much money you’ll be expected to amass over time with that income. But the more your compensation, or your income, looks like a stock or looks like a basket of stocks, the more you have to take that into account, when you’re deciding how to invest your financial capital. I’ll give you an example. Professional athletes have a salary, right, but they have a much different looking lifetime expected income than say, somebody who is going to be working as a teacher for 40 years, right. You’re probably gonna make almost all of your money in three years, or five years or 10 years, and you’re gonna have a salary after that, you’re gonna go on to do other things, but it’s probably not going to be quite the same as when you were playing professional sports. So those people have to think much differently. They’re basically using up a lot more of their human capital earlier in their careers, because you can’t, you know, most people, LeBron James, except in a couple of other people, Tom Brady, aren’t going to be playing at this very high level and earning 10s of millions of dollars when they’re 40 years old. So they have to think of by that age, they basically already amassed a lot of the financial capital they’re going to have, and they have to invest accordingly. Because they don’t only have to make that last in retirement, the way most people do 65 and up, but they really have to think about starting retirement at 40. They might have other income sources, but it’s probably not going to be what they got playing in the NFL or NBA.

Lee Korn  8:42
So if we’re looking at human capital decreasing, right, which is more like your bond allocation, let’s use Tom Brady as an example. Although I’m sure he has enough money with him, and Giselle to last. He could sit in cash for the rest of his life, he doesn’t need a high rate of return. But in this current environment, right, so if you know when bonds are paying 5%, I could understand you, you grow your wealth, you get to a dollar amount where you clip your coupon, you earn 5% and you can live comfortably. You know, I think, this morning, I looked at the 10-year Treasury was at 1.35% and 30-year Treasury, just a pinch over 2%. So someone works their whole life, they spend down their human capital, they, you know, obviously, you have an equity, a fixed income, human capital allocation. And now they’re at a point where they’re ready to live off of their income. Do the rules still apply, you know, shifting assets to fixed income?

Brian Nick  9:37
So the current environment for interest rates, and fixed income in general, is especially challenging for somebody who’s making this transition, right. If you told somebody who retired in 1980, when the 10-year rate was in the teens, you probably could have done quite well in retirement just by taking all the money you had in buying 30-year bonds. And you could have been living off the interest with, you know, with excess for the last 30 years. But currently, as you said, those interest rates you’re quoting are extremely low by historical standards. So if you were, you know, making money, let’s say you’re 25 or 30, and you’re putting that money into a 10-year Treasury or a 30-year Treasury, which I don’t think most people that age are doing. But if you were to be doing that, you’re probably going to, you know, hit the age of 65, and find that inflation has basically taken care of all of your savings. And you really didn’t convert that human capital into sustainable financial capital, which is one reason we tell people at that age, you want to be allocated more to assets that have a chance to grow. Now, let’s fast forward to the question you asked about the 65 year old. Can you still afford to have that very large bond portfolio? Not quite the same way you used to be able to, right. If you have to take some risks somewhere to get a higher rate of return, because right now, over 10 years, the rate of return on the Treasury is less than the expected rate of inflation, which means that you’re going to end up with less money at the end than you started with. And you’re going to find that, you know, inflation is eroding away your lifestyle over time. What you can do instead is look at taking on more credit risk. You can look at other parts of the bond market that are not rated as highly. They might have more properties that make them look more like stocks, but maybe they’re gonna give you a higher yield. You can afford to kind of clip those coupons over time. Or you can look at entirely different kinds of asset classes, you can try to get more income from your equity portfolio using dividends. A lot of stocks in the United States and outside the United States have higher dividend yields than you can get on the bond markets. Even more true, this would be a much even more difficult conversation if we were in Germany right now, because interest rates are negative. And their equity market has not delivered on the growth over time. So it’s even more difficult in lots of other places. But even here in the US, probably looking at the need to be somewhat more aggressive, again, within your designated risk tolerance over time, just to be able to get that same level of income that a lot of people are going to need when they retire.

Lee Korn  11:50
Actually if you bring it full circle, we’re talking about human capital, right? There are other options when we’re doing financial planning with clients. We talk about, okay, so you’ve retired, you could go back to work part-time. I mean, if you think about it from a human capital perspective, if you were earning $100,000 a year, and now you go back part time and earn $40,000 a year, what current interest rates, that’s equivalent to having $2 million in a 30-year Treasury earning $40,000?

Brian Nick  12:17
Absolutely. It’s another option, right? So most people are not necessarily looking to build a portfolio that’s going to replicate 100% of their income upon retirement. So yes, exactly. If you can’t get there, with the bond portfolio, you’re concerned about spending your portfolio down too quickly, you know, lengthening or extending that the value of that human capital by using it to, again, work part-time, or do something else where you’re making a source of income. That’s not your career, but it’s something that you can do for a few years to, you know, while you wait for that portfolio, that nest egg that you save to grow and become more sustainable for that 30 or 40 year retirement.

Lee Korn  12:51
Great. So now that we’ve got a baseline for what human capital is, we’ve looked at a couple of scenarios. So this podcast is mainly for entrepreneurs, business owners as the audience. Let’s pivot to the business owner, right, because the business owner has an interesting situation they’re in. So often the business owner starts out they are the business, their goal is to build a sustainable business that isn’t dependent on the owner, but often, for a long period of time it is, right. So that business owner has human capital, because they’re usually pulling a salary from the business. But they also have risk because their business is their largest asset, right? Highly concentrated, highly illiquid. Often we see business owners, for whatever reason, they feel more comfortable sometimes investing in the industry that they’re in or having a higher risk tolerance, specifically to their business. Maybe we could talk about how a business owner should look at human capital.

Brian Nick  13:45
Sure. And I think you laid out a scenario there, where it’s a business owner who’s able to draw a salary from their business, but they’re not, you know, in a position to sell. So they don’t have this big kind of injection of liquidity coming at some point yet, maybe coming down the road, but it’s not imminent, that person probably has to think about their financial capital allocation somewhat differently. Because they could own a small business that is economically sensitive, right, something like COVID happens with a financial crisis happens and that business could be threatened. So having too much of your both your human capital and your financial capital in one asset effectively introduces more risks. So having more conservative assets outside of your human capital outside of your business might make sense for that person, even though you might say, well, I own this business, why a loan, a municipal bond portfolio? Well, it’s there because it tends to be less correlated to the thing that you’re basically devoting most of your time to, it’s much different. If you’re somebody again, who’s on that sort of scaled salary, your human capital looks almost exactly like that municipal bond portfolio, right? So you want to be allocated in something that’s riskier? Well, in the case of the business owner, the risk is really in their job, it’s what they’re doing, they built this, this company, and they’re hoping to grow it to make it into something else. But if it doesn’t work out, they have to have something to fall back on. So usually, not always, but usually, a business owner would be allocated somewhat more conservatively, in their financial assets than somebody who is drawing a sort of a predictable salary.

Lee Korn  15:06
Do you feel that is the case regardless of where that business in is in the cycle? There are entrepreneurs that are just starting out in business, there are midcycle business owners, there are business owners that are looking to exit over the next few years. Thoughts?

Brian Nick  15:22
Yeah, I think, you know, again, the economically sensitive nature of the business is a really important question is it’s something that’s sort of, you know, going to make it through a one or two recessions or some kind of economic shock. But I think, in general, if you’re planning on selling the business imminently, so we’ll take the completely opposite scenario that the person who’s just starting out, but you’re looking to kind of exit, you’re expecting that big liquidity injection. So your human capital is about to be converted in a massive scale into financial capital. And once that happens, whether or not you kind of mentally, you know, in your head retired, you can look at that as a sort of a retirement event because now you have a much larger share of your net worth in financial assets or maybe it might be cash, whatever you sold the business for, and much less of it now and human capital. And that means becoming more conservative after the event, because you’re basically looking to create that same portfolio that somebody who is, you know, a school teacher or librarian for 40 years. They have to think about their assets at age 65, the same way that somebody who sells out of their business at age 65 has to think about it too. Even if you think you’re gonna start more businesses, take more risk, that liquidity event is probably going to be your defining financial event. And therefore, as you prepare for it, you probably want to think, how am I going to allocate this portfolio once I’m fully liquid, once my human capital is effectively not expended, but drawn down considerably, as I sell out of this very concentrated, riskier asset into things that I can be more diffused, more diversified? So  I think that’s the conversation to have, as you’re approaching that event, is what did your portfolio look like without the constraints of the liquidity of your company? And the very kind of idiosyncratic nature of the risks around your company?

Lee Korn  16:58
Right, so let’s say your business, we talked earlier, your business represents a large percentage of your portfolio. That business is equity, stock. It’s not McDonald’s, Walmart, or Coca Cola, but it’s concentrated. Are there other ways? Let’s say you don’t want to have the majority of your net worth in fixed income? You want to be allocated to the equity markets? We talked about diversification, is there a way to diversify away that risk other than taking into consideration human capital and overweighting in fixed income?

Brian Nick  17:30
Yeah, one thing you can do is to look at the industry that your business is in, but maybe you have a business that is in charge of sort of supplying parts as part of this extremely complicated assembly process for a car or some other piece of technology. You probably want to diversify away to that as best you can. Other aspects of what goes into that product line, right? Maybe you want to diversify away from technology, you want to diversify away from industrials, you want to put money more into consumer staples, things like that, which will tend to bring you into a more conservative place in the portfolio. But for this example, not getting too over allocated to the industry that you’re already in, even though you might feel very comfortable that you know exactly how these companies work. You think these are great companies that make great products. The risk around you know, right now, the semiconductor shortage right now in the car industry affecting appliances, TVs, anything with electronics, anything around that they’re having trouble producing these things. So if you were somebody who was involved in sort of a one link in the chain on producing cars, or producing TVs, this one sort of phenomenon around the world is affecting your ability to produce and make a profit. So diversifying away from that risk makes a lot of sense in your portfolio. And you shouldn’t be 100% in fixed income necessarily anyway, just because you might be a business owner. But thinking about how to diversify away even if it’s not owning 30-year Treasuries, there’s something that gets you a more balanced portfolio when you take both your business and your financial assets into account.

Lee Korn  18:53
Great. We all we often see entrepreneurs keeping excess cash, right. They’re always concerned that they might have to influx cash into their business might not be able to access credit. So I would be remiss not to ask you, we talked about diversification, we talked about correlation. If you own a business that makes car parts, maybe there is a way to invest or overweight other asset classes or other industries that would zig when when your business is zagging. Sure, there are periods in time when correlations go to one, right, where stocks and bonds both go up or both go down. Gold goes up while everything else is going up. There are times, you know, when they say a rising tide lifts all boats and decreasing brings all all boats down. I would be remiss to ask you, with your expertise, your thoughts on correlation? Do you still think that traditional asset allocation gives you that protection?

Brian Nick  19:51
I guess this point I’m old fashioned for saying yes. And in the second quarter was interesting example because everything went up in the second quarter. Right? We think of like correlations go into one and usually a bad thing we think of the financial crisis. We momentarily in 2020, when liquidity was extremely tight, US Treasuries were dropping in value, even gold got hit by liquidity, which when gold’s getting hit by liquidity trade, it’s a problem cause everybody just wanted to own cash. So that tends to be an extremely, I think, rightly so an extremely uncomfortable environment for investors because they’re seeing red ink and everything in their portfolios. The second quarter was a nice counter example, which is when correlations go to one or when there tend to be positive last quarter, we had interest rates fall, we had stock prices increase, we had credit spreads tightened basically everything did well. Even gold was up a couple of percent last quarter. So it can work over I think short periods, over long periods. If we look at this over days, you see a lot of volatility over weeks. You see a lot of volatility, look at it over periods of years. If you look at the sort of the monthly correlation stocks and bonds over the last five years, it’s been positive since 1990. So there’s still a… sorry, that between interest rates and stocks it’s been positive since 1990. So as interest rates move up, stock market tends to do well, so means bonds are losing money in your portfolio, stocks are doing a bit better. And that’s really been with us since the sort of low inflation, globalization story and the internet coming online in the 1990s. A lot of things happened to make these financial markets behave a bit better. I think people who remember the 1970s and 1980s, remember a time when stocks and bonds were positively correlated and interest rates going up was not good for stocks, it was a sign that inflation was going to be a problem. Since we’ve been out of that period, since the central banks, I think, have exerted more control over inflation. And now we think of 3% inflation is high, the bond market doesn’t behave the way it used to. Things can change again, but I think the biggest problem that investors have, if they’re looking for diversification is not the lack of correlation. It’s just the fact that bonds are already so rich, that you’re looking at, okay, what’s going to happen if the stock market falls 30%? What’s the 10-year going to do? It’s going to go from 1.3 to .5 or .3, could go to zero, sure, but it’s not going to give you the same bang for your buck. You’re gonna lose more money in the stock market than you’re gonna make in the bond market, because interest rates are already so close to zero. And that’s the problem that I think that investors face is the correlation is still there. But if you look at what you’re actually getting, for every x percent you lose in stocks, what are you gaining in bonds, it’s not the same as it used to be. And there’s a couple of ways you can work around that. You can, you can just, you know, accept more risk in the portfolio, you can go into other asset classes that are completely or not, not as correlated and look at things like real estate, other real assets. Gold is an example of something that has sort of an unpredictable correlation. The more of those you introduce into a portfolio, the smoother the ride tends to be sort of risk adjusted, return tends to be a bit better.

Lee Korn  22:38
And if you think about bonds as your conceptual dry powder, if you think about it in March when the markets drop, and even fixed income was down a bit. But if you’re able to rotate and buy stuff at a 30 or 40% discount, you know, we had the sharpest drawdown and the sharpest recovery, not that we knew was gonna be a super v recovery.

Brian Nick  22:59
The only positive thing you can say about last March, or the COVID crisis that happened in March, so investors that were looking to do quarterly rebalancing, anyway, actually ended up buying it almost exactly the right time, almost to the day. So March 23, was the bottom sometime that week is when people are doing their quarterly rebalancing if they’re doing it, and you ended up buying at a pretty good point, even in June. You know, in retrospect, if you’re doing semiannual rebalancing, it was still a very good time to sell out of your bond portfolio which had made you some money and move into your equity portfolio. The issue with last spring, other than the obvious COVID in the lockdowns, was that liquidity became so scarce because people seriously did not know what was going to happen. So everything in the market was basically up for grabs. You were selling out of your Treasury portfolio, the biggest and most liquid fixed income market in the world, and people were selling it and going to cash they were selling gold or selling stocks. And that’s why everything’s going to one and it’s really only after the Fed came in and basically promised unlimited amounts of liquidity, if things started to behave normally again, and the bond market was the first market to bounce back. Because in a crisis where you don’t know exactly what the economy’s gonna do, interest rates are going to fall. The bond market, anybody who was you know, a bit patient was making money on higher quality parts of the fixed income market pretty soon, and then the stock market came roaring back too.

Lee Korn  24:21
Great, I’ll ask everyone in this podcast to forgive me, I’m a bit of an investment geek. So when I’m sitting with the chief investment strategist, I’m gonna go there. I’m gonna ask my questions. I promise we’ll get back to human capital in a minute. But you’d mentioned inflation. Everyone’s concerned about inflation. Fed says it’s transitory, market is saying it’s transitory. Obviously, interest rates have been going down. You know, my thought is, inflation isn’t bad. Japan has been trying to manufacture inflation for a very long time, actually, when you have big debt, inflation is your friend. We talk about this concept often. Maybe you could just elaborate on that.

Brian Nick  24:56
Sure, well put simply, inflation is just you know, too much demand chasing too little supply. And I think you can look at almost anywhere right now, you can look at almost any store that has a help wanted sign on it, you can look at almost any kind of commodity, any manufacturer that depends on raw materials, you can understand why, right now there’s too much demand chasing too little supply. And that’s why this spring has been really the hottest period for inflation in most investors’ living memory. I mean, unless you were actively in the markets before 1990, you don’t remember inflation that looked like this. That’s been a long, a long period of time. So what we’re really seeing is a combination of things. I mentioned semiconductors earlier. There’s kind of idiosyncratic specific examples of shortages that are really having these severe downstream consequences, right. If you have shortage of one part that goes into a million different products, there’s gonna be a problem with all the manufacturers of those products trying to get those online. And we know a well stimulated US consumer is buying a lot of stuff or had been buying a lot of stuff throughout most of COVID. Right now, what we’re seeing is people are coming outside, they’re doing more things, frankly, experiential things, things that they want to take a picture of and post on Instagram, like taking a vacation, or going on a flight, going out to a meal. As the US consumer rotates out of goods as fewer people get their, you know, homes redone or get new appliances or bigger TVs, and they start going into services sectors, we’re gonna see the prices of those things go up too. We’ve seen airline prices go up, we’re seeing hotel room rates go up. Not back to where they were, not even close, air fares are still down about 20% from the peak. And so if you’re looking at the next couple of months of inflation, we have an inflation number coming out pretty soon CPI, that’s going to probably show airfares continue to move up. But it’s probably going to show less inflation, and things like appliances, used cars, believe it or not have been the single largest driver of inflation this year aside from oil and gas. You can’t expect that to last. If we keep seeing used car inflation, the way we are, the preceding used cars will be worth more than new cars and probably not an economically sustainable way to be. So we think probably have seen the peak for monthly inflation numbers already this year. Year on year, it’ll still appear high. And then it’ll come down pretty quickly in 2022. As the effects of this spring, the very unique nature of the reopening, the pent up demand, the stimulus that a lot of people use to buy big ticket items. And then the service summer that I think we’re about to have where people are going out and doing things and companies or firms are scrambling to hire workers to meet that demand. All those things will eventually work their way out. It may be uncomfortable, we have uncomfortably high inflation, I’d say in the US right now. But I think the Fed will eventually be borne out as correct. Maybe they didn’t appreciate how high inflation was going to pick this year. But I think the transitory nature of it will be apparent sometime in the next couple of quarters.

Lee Korn  27:42
Right, fly into West Palm Beach or Fort Lauderdale or Tampa and try renting a car, you’ll pay twice as much.

Brian Nick  27:48
Because the rental car companies sold their fleets last year, thinking this wasn’t gonna come back anytime soon. And now they’re scrambling to buy back cars. And there’s a shortage because of the semiconductor. So used cars and rental cars that were sort of at the nexus of a lot of these problems. And that’s why you’ve seen so much inflation in this one area of the economy.

Lee Korn  28:06
Alright, let’s pivot back to human capital. So human capital, is your earnings potential going forward. Right? Job market has certainly not been stable, right? So if you were looking at human capital as an asset class, just as we would equities, we would be making changes, we would be tweaking the allocation possibly. How do you do that with human capital? So you were, let’s use the example of a bond trader who worked on Wall Street in 2008. And then his job disappeared, and didn’t get repurposed, because everything went digital or the markets went away. There are lots of jobs that have disappeared, that great companies have found ways to increase productivity to digitize to not bring back that worker. So if you’re in an industry and your earnings potential changes, how should you be thinking about your asset allocation? Should you be making changes or?

Brian Nick  29:01
Yeah, I think the example you just mentioned that bond trader in 2008. I mean, that was probably somebody who probably had a lot of human capital, had already used some of the human capital to amass probably considerable financial assets. But that was very tied to A) the economy and B) the financial markets, and specifically the financial system. So when you have that complete financial meltdown, that doesn’t just last for a short period, it really changes the way that the business is done on Wall Street. And just how many of those jobs are available and what they pay, you’ve taken sort of a permanent hit. So let’s say you know, you get another job, it’s in a completely different type of industry. And it’s something that, you know, is less correlated to the economy, to the financial markets, but also the trajectory of just going to be lower moving forward. But maybe more predictable as well, you probably want to think about allocating more aggressively in your accumulated financial assets. As counterintuitive as that might sound about somebody who, you know, had a job loss in 2008, you probably need to make that nest egg work a little bit harder, because you’re not going to be accumulating at quite the same rate, that your human capital trajectory has lowered somewhat, at least temporarily. So maybe that person thinks about becoming somewhat more aggressive in their financial assets, especially if they’re young. And, and getting sort of counterintuitive. The other way to look at it is if you’re working in something that has, you know, a predictable salary, low salary, but you come up with an invention or you want to start a company that dramatically changes human capital in sort of the opposite way, right? You start to, you know, take more risk in your own business, coming up with your own ideas, and you have more risk around that particular endeavor. You’re probably whatever you’ve amassed so far, want to be somewhat a little bit more conservative than the first example.

Lee Korn  30:39
Great. Yeah, it’s something that we deal with often. We usually start when we’re talking about financial planning and building out a financial plan and talking about risk that a client is willing to take, talking about goals, usually building in cash buckets, depending on their stability of their income.

Brian Nick  30:54
Yeah, having those cash buckets I mean, you know, cash is not paying you a lot right now to hold it but it is important to think about, you know, what would I need for the next six weeks months, one year, three years if something calamitous happened right now. If I was injured, unable to work if I lost my job, and having that sort of buffer between you and a dramatic sort of lifestyle, downgrade or change. Even before you start talking about what your pie chart looks like, stocks, bonds, real estate, whatever it is, having that, you know, that sort of sleep well at night fund even if it’s not a sort of a high return asset has to be something that’s liquid. I think that makes sense, especially for somebody who’s an entrepreneur, somebody who’s at almost any stage of owning businesses, you mentioned that a lot of times they want to own a little bit more cash. Financially, if you’re looking at sort of an optimization, the optimizer probably wouldn’t tell you to own that much cash. But if you’re talking about a financial plan, it’s a much different thing than just pushing a button and letting an algorithm do it.

Lee Korn  31:45
Certainly, there’s a psychological aspect.

Brian Nick  31:47
Absolutely. And it will probably make you a better investor in the rest of your portfolio if you know that you have that liquidity to fall back on.

Lee Korn  31:52
I’m going to lobby the CFA Institute to add human capital as an asset category, right. You’ll have your pie, you’ll have your stocks, your bonds, you’ll have a stick figure, yourself or myself, and we’ll have cash.

Brian Nick  32:05
And you can assign it an expected return, and a risk around that return to your human capital, and you can model it to grow over time to the same way you can any asset class, right? So it’s we just stick it in like a you know, mean variance, Black-Litterman, whatever the model you’re going to use. Hard to do it, but you have to think about it as you’re deciding how to allocate those financial assets. Because for most people, especially people who are younger, human capital is, you know, the vast majority of their net worth, even if they don’t appreciate it, even if it’s not on paper, and there’s not a quantifiable type sort of target behind it.

Lee Korn  32:37
Awesome. Last question, okay. It’s not something we’ve talked about, but it’s questions we’re getting a lot and has nothing to do with human capital, although we’re sitting here we’re talking and geeking out in investments. Bitcoin. Okay. I’m sure you get hundreds of questions. Thoughts on it?

Brian Nick  32:57
So when I was talking about the second quarter about how everything did well, I didn’t mention Bitcoin, because Bitcoin was one of the things that did extremely poorly in the second quarter after doing well, in the first quarter. You know, just talking about those financial models, and, you know, putting returned estimates and trying to figure out what the optimal mix of asset classes is. And the problem with Bitcoin is it doesn’t really work in those kinds of models, right? Because there’s no expected return, it doesn’t have a yield, it doesn’t have a risk premium, like a stock does. You don’t think, well, if I own this, S&P 500 index fund, it’s gonna make 4% over the US Treasury. There’s no predictability to it. And the correlation, it has the other asset classes, I’m not talking just about Bitcoin, but cryptocurrencies in general, is also extremely unstable and predictable. So how do you model it? How do you decide I want X percent of my portfolio to be in crypto or Bitcoin? We think the answer is probably you don’t want to do that. You look at it as more of something you own, that has a very unpredictable value. You may derive some sort of psychic income right from owning it, right? The same way that people own art or collectibles. But if you want to say I’m going to put this into my kid’s college fund, you know, something that’s going to be worth more in 30 years than it is now, I’d say look at other types of asset classes for that, because it’s very hard to figure exactly what the future is going to be for any single one of these coins, let alone for you know, the one specific one that you’re going to pick. It’s hard for me that’s sort of like, you know, again, a little bit old school fashion in terms of thinking about the mean variance optimization and diversification helping you and introducing sort of a wildcard like this. You end up basically wanting either 100% of your portfolio or zero, and neither one of those may be the right answer.

Lee Korn  34:38
Good answer. I got a call from my brother when he was in Miami, two and a half months ago. And he said, “Sitting at the pool with someone and he told me put everything in crypto. So let’s go ahead and do it.” And I won’t use some of the four letter words that I used, but in the Cliff’s notes version in 10 words, or less, we didn’t do it.

Brian Nick  34:58
So you can you can put your human capital into bitcoin by working for one of these companies. Right? I think that that automatically would make me think you shouldn’t own any of your financial capital, you already exposed that. But as it happens, I was also at a pool party this weekend where somebody was asking me about crypto and saying they had made a lot of money. And I said, just remember your password. Because those people that got locked out, yeah. But after the appreciation happened, they were not able to collect so there’s a lot of risks around it. I would say being diversified and assets that we know something about that we know how they behave, that we know what their intrinsic value is, is still the way to go.

Lee Korn  35:29
It’s great. Bringing it back to human capital, right? There are a lot of people that are putting their human capital in Bitcoin, in blockchain, and they’re doing quite fine. So yep. All right. Well, Brian, this was great. Thank you very much. We really appreciate you having you here.

Brian Nick  35:45
Great to be here. Great to be back in an office and hope we can do more of these.

Lee Korn  35:46
Awesome and happy belated Fourth of July.

Brian Nick  35:47
Same to you. Thanks very much, Lee.

Lee Korn  35:48
You got it. Thank you for listening. If you have any questions about what we’ve discussed today and how it might affect your own situation, feel free to call me at 516-388-7980 or drop me a note at Lee dot Korn at opalwealthadvisors.com. We’d love to hear your comments and answer any of your questions. I also encourage you to subscribe to our podcast on Spotify, Apple Podcasts, Google Podcasts, and Stitcher. Sign up at opalwealthadvisors.com/bizmoney to be kept in the know on what’s coming up in our series. Thanks again for joining us and we’ll see you next time on Biz Money.