Standard capital asset pricing theory does not apply to investors whose consumption depends primarily on earned income, rather than on securities. To apply, the theory must recognize two kinds of systematic risk—fluctuations in the general level of market values and (unexpected) fluctuations in general prosperity.

The consumption a security can support during periods of low earned income depends on what it can be sold for in such periods; its value at other times is irrelevant. If he is more likely to be unemployed when the level of national income goes down, the wage earner should avoid securities whose prices correlate strongly with the business cycle. If, on the other hand, his earned income is insensitive to the business cycle, he should own a larger proportion of cyclical investments than standard capital asset pricing theory would predict.

Those who offer investment counsel need to consider carefully the risk character of their clients’ earned income, and design portfolios that diversify against those risks.