Is Conventional Financial Planning Good for Your Financial Health

Abstract

Economics teaches us that we save, insure, and diversify in order to mitigate fluctuations in our living standards over time and across contingencies. While the goals of conventional financial planning appear consonant with such consumption smoothing, the actual practice of conventional planning is anything but. Conventional planning’s disconnect with economics begins with its first step, namely forcing households to set their own retirement- and survivor-spending targets. Setting spending targets that are consistent with consumption smoothing is incredibly difficult, making large targeting mistakes almost inevitable. But, as shown here, even small targeting mistakes, on the order of 10 percent, can lead to enormous mistakes in recommended saving and insurance levels and to major disruptions (on the order of 30 percent) in living standards in retirement or widow(er)hood. There are three reasons why small targeting mistakes lead to such bad saving and insurance advice and such large consumption disruptions? First, the wrong targeted spending level is being assigned to each and every year of retirement and widow(er)hood. Second, planning to spend too much (little) in retirement and widow(er)hood requires spending too little (much) before those states are reached. This magnifies the living standard differences. Third, saving and

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