The effectiveness of consumption smoothing: theory vs practice

Economists have established life-cycle optimization models for households that are designed to maximize utility by smoothing consumption. Franco Modigliani won the 1985 Nobel Peace Prize for his development of these life-cycle equations. They model a household’s living standard to remain constant throughout their lives. In theory, the models effectively prescribe households an allocation of savings & consumption to maximize utility by smoothing consumption over a lifetime. In practice, real-world complexities like regulatory changes, the timing of social security filing, fluctuations in Medicare premiums, required minimum distributions, investment account tax structure, willpower to implement the plan, etc., may cause the models to break. I examine a financial planning software that adheres to the consumption smoothing theory, and test its effectiveness in practice.