I am sincerely grateful for the constructive comments of two anonymous referees and Wouter Den Haan, the editor. In addition, I thank Ralph Bradburd, Bill Gentry, Ken Kuttner, Joachim Winter, Steve Zeldes and seminar participants at Williams College and Columbia Business School for helpful comments and discussion. All errors are my own.
Optimal Rules of Thumb for Consumption and Portfolio Choice
Article first published online: 2 JAN 2013
© 2013 The Author(s). The Economic Journal © 2013 Royal Economic Society
The Economic Journal
Volume 123, Issue 571, pages 932–961, September 2013
How to Cite
Love, D. A. (2013), Optimal Rules of Thumb for Consumption and Portfolio Choice. The Economic Journal, 123: 932–961. doi: 10.1111/ecoj.12002
- Issue published online: 18 SEP 2013
- Article first published online: 2 JAN 2013
- Accepted manuscript online: 18 SEP 2012 06:03AM EST
- Manuscript Accepted: 21 AUG 2012
- Manuscript Revised: 13 FEB 2012
Conventional rules of thumb represent simple, but inefficient, alternatives to dynamic programming solutions. This article seeks an intermediate ground by developing a framework for selecting optimal rules of thumb, where rules of thumb are defined as simple functions of state variables. In the case of portfolio choice, optimal linear age rules lead to only modest welfare losses relative to the dynamic programming solution, while a linear rule based on the ratio of financial wealth to total lifetime resources performs even better. Consumption rules generate larger welfare losses but an effective rule is to consume 70–80% of annuitised lifetime wealth.