Human capital and popular investment advice

Popular investment advice recommends that the stock/bond and stock/wealth ratios should rise with investor risk tolerance and investment horizon respectively, prescriptions that are difficult to reconcile with standard models of portfolio choice. Canner et al (1997) point out that the first piece of advice can potentially be explained by human capital considerations, but only by exacerbating the puzzle surrounding the second piece of advice. However, we show that human capital can simultaneously justify both pieces of advice, so long as the correlation between human capital returns and stockmarket returns lies within a range that depends on market and investorspecific parameters. Historical data comfortably satisfy this requirement for the average investor.UnpublishedNon Peer ReviewedJ Ameriks and S Zeldes, 2000. How do household portfolio shares vary with age? Coumbia University working paper. Z Bodie, R Merton and W Samuelson, 1992. Labor supply flexibility and portfolio choice in a life cycle model. Journal of Economic Dynamics and Control 16, 427-449. M Brennan and Y Xia, 2000. Stochastic interest rates and the bond-stock mix. European Finance Review 4, 197-210. J Campbell, J Cocco, F Gomes, and P Maenhout, 2001. Investing retirement wealth: A life-cycle model. Risk Aspects of Investment-Based Social Security Reform, chapter 11, eds J Campbell and M Feldstein. University of Chicago Press, Chicago, Illinois. J Campbell and L Viceira, 2001. Who should buy long-term bonds? American Economic Review 91, 99-127. J Campbell and L Viceira, 2002. Strategic Asset Allocation, Oxford University Press. N Canner, G Mankiw, and D Weil, 1997. An asset allocation puzzle. American Economic Review 87, 181-91. E Dimson, P Marsh and M Staunton, 2002. The Triumph of the Optimists. Princeton University Press. E Elton and M Gruber, 2000. The rationality of asset allocation recommendations. Journal of Financial and Quantitative Analysis 35, 27-41. F Gomes and A Michaelides, 2002. Life-cycle asset allocation: A model with borrowing constraints, uninsurable labor income risk and stock-market participation costs. London Business School working paper. R Jagannathan and N Kocherlakota, 1996. Why should older people invest less in stocks than younger people? Federal Reserve Bank of Minneapolis Quarterly Review, 11-23. B Malkiel, 1996. A Random Walk Down Wall St (6th ed.) New York: Norton. J Tobin, 1958, Liquidity preference as behavior towards risk, Review of Economic Studies, 65- 86