Life-Cycle Finance in Theory and in Practice

Abstract

This paper draws upon the modern science of finance to address several important practical issues in personal finance. Chief among these is how much to save for retirement and how to invest those savings. The paper suggests ways that advances in the theory of finance combined with innovations in financial contracting technology might be used to improve social welfare by designing and producing a new generation of user-friendly life-cycle products for consumers. It contrasts the old Markowitz single-period paradigm of efficient diversification with a new Mertonian paradigm that takes account of multi-period hedging, labor supply flexibility, and habit formation.

Keywords: life-cycle finance, personal investing, personal financial planning, Markowitz paradigm, Mertonian paradigm

JEL Classification: D11, D91, E21, G11, J2, J26