Episode summary
James Choi: Portfolio Theory in a Spreadsheet | Rational Reminder 399
The Rational Reminder Podcast
· · Hosts: Benjamin Felix, Braden Warwick, Cameron Passmore · Guests: James Choi
Summary
James Choi explains the life-cycle portfolio choice problem as deciding how much of total wealth should be in stocks versus bonds once human capital is included. In the simplest Merton setup, risk-free labor income can be treated like a bond, but with risky labor income the problem becomes much harder to solve exactly. The earlier Gomes, Cocco, and Maenhout work handled that numerically and showed that human capital often behaves more like a bond than a stock when labor-income risk is largely uncorrelated with the market.
Choi and co-authors’ contribution is to approximate that complex solution with a spreadsheet-friendly rule. They solve thousands of parameter sets, back out effective discount rates for future labor income, and then fit simple formulas that get very close to the numerical optimum. Choi says the approximation is typically only a few percentage points away from the exact solution, and the welfare loss from using it instead of the full optimization is under 0.1% over a lifetime.
He argues that common rules of thumb are not disastrous but are materially worse than a model tailored to human capital, wealth, age, risk aversion, and expected returns. The spreadsheet version is meant to make the advice usable for normal people, including a simplified version that imputes future wages from current income. The model tends to recommend higher equity allocations than popular advice because many people already have a large implicit bond position in their future wages.
Key takeaways
- Choi says the key insight is that human capital must be counted as part of total wealth, and for many households it acts like a large bond position.
- The approximate rule is very close to the numerical optimum, with about a 0.1% lifetime welfare loss and only a few percentage points of average allocation error.
- According to Choi, 100 minus age and 60/40 are “not bad,” but they still lose materially more welfare than the spreadsheet-based solution.
- Choi says permanent labor-income risk matters much more than transitory risk for portfolio choice, and education can change which risk dominates.
- Choi’s model often recommends very high equity allocations for younger households because their future wage income already provides bond-like exposure.
- He says housing is too hard to model cleanly, so the practical recommendation is to ignore home equity and mortgage debt in the investable-net-worth input.
Notable quotes
“the question is how do you adjust your asset allocation optimally to give you know given the fact that you have this wage income that's coming to you”
“the presence of risk-free human capital is going to make your financial portfolio optimally much riskier as kind of a percent in percent allocation terms”
“It's the permanent income risk that is really scary and causes uh you to uh choke up on the bat essentially and and uh become more conservative in your portfolio”
“less than a.1% uh welfare loss over the course of the lifetime”
“when you have human capital, equities are kind of awesome for you”
How the episode opens
This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, chief investment officer, and Cameron Passmore, chief executive officer at PWL Capital. And welcome to episode 399.
Ben, we had feedback from a listener, at least one listener, that they wish that kind of the podcast I go back to, it's more mathy roots. Well, I would suggest that today absolutely crushed that request. And this conversation with repeat guest professor James Choi phenomenal phenomenal and interesting person in terms of what he's up to and how he thinks and how he communicates.
absolutely deliberate on being more mathy but also extremely practical which is his whole his whole brand is practical finance right making complicated decisions easier which is also what this podcast is all about but wow what a conversation so I I you have to queue it up but man I thought it was phenomenal yeah I I saw James speak uh at a conference last year and he he was actually speaking about uh Scott Cedarberg's paper. he he was a discussant um and it was just a great it was a great uh discussion of that paper and he he made a bunch of really interesting points uh that he covers in one of his new papers and so I of course read that paper which I think was a work in progress the last time we talked to him if I remember correctly but I I I went through this new paper that he has out um which is titled practical finance an approximate solution to life cycle portfolio choice uh and it's honestly so good. It's just such a good paper.
It's such a good discussion of portfolio choice, which is just how to how to pick how much you should invest in stocks versus bonds.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- portfolio allocation
- lifecycle portfolio choice
- equity vs bond risk
- labor income risk
- portfolio optimization approximation
Companies and tickers mentioned
- PWL Capital
Watch the episode
Watch “James Choi: Portfolio Theory in a Spreadsheet | Rational Reminder 399” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
More from The Rational Reminder Podcast
-
Wealthy People Are Hiding in Plain Sight (ft. Owen Zidar) | Rational Reminder 428 -
What to Know Before (and After) You Hire an Advisor (with Matthew Taylor) | Rational Reminder 427 -
The Finances of Marriage | Rational Reminder 426 -
The Ethics Problem in Financial Services (Dr. Moira Somers & Philippa Hann) | Rational Reminder 425 -
50 Years of Evidence-Based Investing (with David Booth) | Rational Reminder 424 -
The Future of AI in the Workplace | Special Episode (Mike Sullivan and Vinay Gidwaney)
The Rational Reminder Podcast, this episode and its artwork belong to Benjamin Felix, Cameron Passmore, and Dan Bortolotti. Octagon is not affiliated with the show; this page is an independent summary.
