Economics-based and conventional financial planning bear no connection. Economics-based planning is grounded in the life-cycle theory and forms the basis for 11 Nobel Prizes awarded in finance economics. The central premise is that households seek a smooth living standard over time and across times -- good times and bad. The theory explains saving, spending, insurance, and portfolio diversification decisions. Conventional planning bears no connection to economic theory. Instead, it constitutes a collection of ad hoc rules of thumb, which guide households to make wildly inappropriate financial decisions. 

Learning Objectives:

• Recall the history of financial economics


• Define the life-cycle model and recognize its prediction of consumption smoothing


• Determine how to differentiate conventional financial planning and economics-based financial planning 


• Identify how conventional financial advice is at odds with economic theory, common sense, and everyday behavior


• List examples of economics-based planning and the extent to which conventional planning recommendations differ