Insights from Life-Cycle Financial Planning

Economics teaches us a lot about financial planning, and perhaps the best way to gain insights is by talking to a financial planner who also happens to have a Ph.D. in economics from a top university. I recently interviewed Rick Miller who runs Sensible Financial Planning in Waltham, Massachusetts. We specifically focused on how he applies his economics training to his overall approach to financial planning, and how he deals with particular aspects of planning such as retirement withdrawal strategies or recommendations about insurance products.

Miller earned his doctorate at the University of Chicago where he studied family economics, which includes lifetime planning. He taught economics at Johns Hopkins University for a few years, and then worked as a consultant and in the investment business. Through his work, he got involved in researching ways to extend investment management into a broader financial planning context, and this experience served as a basis for going out on his own and founding Sensible Financial in 2002.

Initially Miller focused on investment management for clients, but quickly recognized that clients asking the question – “How am I doing?” – were looking for more than a presentation about how their investments were performing against benchmarks. What they really wanted to know was how their overall financial plan would affect the way they lived. This led Miller to apply the economic concept of life-cycle planning to his work with his clients.

Financial planning and consumption smoothing

Life-cycle economics contributes two foundational concepts to financial planning. The first is that individuals and couples must accumulate savings during their working years to support themselves in retirement. How much to save while working and how much to spend in retirement are together the fundamental financial planning problem. The second concept is consumption smoothing. In simplest terms, clients prefer to maintain a steady standard of living over the full cycle of accumulation and decumulation.

An economic focus on consumption smoothing places the planning emphasis squarely on annual spending over the life-cycle (including projected levels, variability and risks of disruption) rather than on conventional performance measures such as asset balances and probabilities of plan failure.