The “life-cycle model” of optimal saving for retirement is familiar to anyone who has taken an intermediate economics class. When hiring a financial advisor, such people probably think the advisor’s job is to tailor optimal life-cycle model choices to their particular circumstances. But academics and advisors know that the advice about both saving and portfolio choice provided by standard life-cycle models is deeply problematic. In particular, most such models imply that retirees should plan to run their wealth down to nearly zero and then live pension check to pension check in their old age. This article makes the case that recent developments in the economics literature have finally given us the tools and insights required to construct rigorous life-cycle models whose advice is sensible. We provide an example of a simple model that can solve a number of problems by putting wealth in the utility function, which captures the intuitive desire for liquidity and security that standard models often overlook.
Carroll et al. (Fri,) studied this question.