Rules of Thumb in Life-cycle Saving Decisions

Authors


  •  Corresponding author: Joachim Winter, Department of Economics, University of Munich, Ludwigstr. 33, D-80539 Munich, Germany. Email: winter@lmu.de.

  • This article is a substantially revised and extended version of unpublished research by Rodepeter and Winter (1999). We thank Michael Adam, Axel Börsch-Supan, Thomas Crossley, Angelika Eymann, Werner Güth, Silke Januszewski, Ronald Lee, Alexander Ludwig, Annamaria Lusardi, Daniel McFadden, Matthew Rabin, Paul Ruud, Daniel Schunk, the special issue editor (Rachel Griffith) and referees, and participants at numerous seminars and conferences for helpful discussions and comments. We gratefully acknowledge financial support by the Deutsche Forschungsgemeinschaft (DFG) through SFB 504 at the University of Mannheim (Rodepeter and Winter) and through GRK 801 at the University of Munich (Schlafmann). Kathrin Schlafmann also gratefully acknowledges support by LMU Mentoring.

Abstract

We analyse life-cycle saving decisions when households use simple heuristics, or rules of thumb, rather than solve the underlying intertemporal optimisation problem. We simulate life-cycle saving decisions using three simple rules and compute utility losses relative to the solution of the optimisation problem. Our simulations suggest that utility losses induced by following simple decision rules are relatively low. Moreover, the two main saving motives reflected by the canonical life-cycle model – long-run consumption smoothing and short-run insurance against income shocks – can be addressed quite well by saving rules that do not require computationally demanding tasks, such as backwards induction.

Ancillary