The Importance of Simplifying Down the Lifecycle Model

Household finance has grown considerably as a field of study in recent years. And with the decrease in defined benefits pension plans, households are increasingly needing to take more responsibility for their own financial fates (much more so than they needed to in the past). Joining us today to discuss household finance and the growing importance of households in the economy, is Professor Francisco Gomes. Francisco is a Professor of Finance at London Business School and earned his PhD in economics at Harvard with his main areas of expertise being household finance, capital markets, asset allocation, and macroeconomics. In our expansive conversation with Francisco, we discuss the increasingly important role of households in the economy, how this has contributed to household finance becoming a more prominent field of study, and what can be done to make sure that academic findings reach, and positively impact, households. Francisco shares a detailed outline of what he’s learned from his research, covering topics like level of education, automation at work, peer effects, and culture, with explanations of how these elements can impact household financial decisions. We also learn about his passion for financial literacy, why he is such a big proponent of ensuring that everyone has access to a quality personal finance education, and the personal finance course he currently teaches at London Business School. To learn more from Francisco about the study of household finance and how to improve outcomes for households, be sure to tune in today!

Key Points From This Episode:

• What it means to maximize your wealth over your lifetime and the crucial ratio determining optimal asset allocation. (0:02:53)
• How optimal asset allocation changes over your life cycle and how our human capital diminishes with age. (0:08:08)
• Building a buffer stock of wealth and the evidence that people become more comfortable with risk as they get richer. (0:10:03)
• The importance of simplifying life cycle asset allocation models to help households make decisions and have a tangible impact on people’s lives. (0:16:28)
• The biggest gap between theory and what households do; not investing in stocks. (0:20:32)
• An overview of the biggest mistakes people make when they invest in stocks and why it ties back to financial literacy. (0:23:49)
• How the process of optimizing asset allocation changes at retirement, the importance of hedging longevity risk, and why annuities are so useful. (0:25:40)
• A rundown of some of the reasons behind why annuity uptake is so low and why it is often referred to as the annuity puzzle. (0:29:20)
• The impact of automation in the workplace on household wealth accumulation and how exposure to automation is measured. (0:35:02)
• How one’s level of education affects the interaction between automation and wealth and how households should respond to automation at work. (0:38:12)
• Lessons from Francisco’s research for households thinking about the future after a change in their financial situation. (0:45:18)
• Why household finance has become more prominent as a field of study in recent history and what economists need to do to ensure their findings positively impact households. (0:47:30)
• How culture can influence household financial behaviour and the evidence that people learn from their peers. (0:50:47)
• Insights into the potential for financial advice to improve the finance of households and why Francisco is such a big proponent of personal finance education and financial literacy. (0:52:35)
• Learn about Francisco's personal finance course at London Business School and what he’s most excited about in his upcoming research. (0:54:01)

Participate in our Community Discussion about this Episode:

https://community.rationalreminder.ca/t/episode-262-francisco-gomes-consumption-and-portfolio-choice-over-the-life-cycle-discussion-thread/24433

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.  Rational Reminder Website — https://rationalreminder.ca/ 

Shop Merch — https://shop.rationalreminder.ca/

Join the Community — https://community.rationalreminder.ca/

Follow us on Twitter — https://twitter.com/RationalRemind

Follow us on Instagram — @rationalreminder

Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore

Prof. Francisco Gomes on Twitter — https://twitter.com/Franc_J_Gomes

Prof. Francisco Gomes — https://sites.google.com/view/francisco-gomes/home

'Optimal Life-Cycle Investing with Flexible Labor Supply: A Welfare Analysis of Life-Cycle Funds' — https://www.jstor.org/stable/29730037

'Consumption and Portfolio Choice over the Life Cycle' — https://academic.oup.com/rfs/article-abstract/18/2/491/1599892?redirectedFrom=fulltext

' Portfolio Choice Over the Life Cycle: A Survey' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3744669

'Longevity risk, retirement savings, and financial innovation' — https://www.sciencedirect.com/science/article/abs/pii/S0304405X11002339

'Stock Market Participation and Portfolio Shares Over the Life Cycle' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3808350

'Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence' — https://www.jstor.org/stable/3694770

'Do Robots Increase Wealth Dispersion?' — https://academic.oup.com/rfs/advance-article-abstract/doi/10.1093/rfs/hhad050/7192998?redirectedFrom=PDF

'Evidence on Expectations of Household Finances' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3229980

'Household Finance' — https://www.aeaweb.org/articles?id=10.1257/jel.20201461