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I think it generally makes sense to try to smooth personal consumption, but that for most people I know this still implies a high savings rate at their first high-paying job.
For the point about smoothing consumption, does that actually work given that retirement savings are usually invested and are expected to give returns higher than inflation? For instance, my current savings plan means that although my income is going to go up, and my amount saved will go up proportionally, the majority of my money when I retire will be from early in my career.
For a more specific example, consider two situations where I'm working until I'm 65 and have returns of 6% per annum (and taking all dollar amounts to be inflation adjusted):
In the first situation, if I contribute $1000 monthly, I'll retire with about $2.4 million, 79% of which is from interest. In the second situation, to get the same amount at retirement, I have to contribute $2500 monthly, and only 63% of the balance will be from interest. I don't expect to be making 2.5 times as much at 35 as I was at 21, so smoothing consumption is worse for me.
This gets even worse when you consider than you should move to lower risk investment plans as you get closer to retirement, since you'll have to be contributing even more. As an counterpoint to this, some people even recommend investing on the margin when you're young to get even higher returns, though I'm not bold enough to do that.
I guess my biggest disagreements with the paper is that income (for at least me and for people I have compared notes with) is not hump-shaped enough for the effect to dominate, and their assumption that "the rate of time preference equals the interest rate" seems to be to simply not be true even though economists like to assume it is. I think the second assumption is the one I disagree with more, since I (and again, many people I have talked to) have very little time preference for the present. If I had two buttons, to give me $1000 of consumption today, or $1001 of consumption in thirty years (inflation adjusted of course), I would press the second button. But economists assume that I would only do that if the second button was something like $6000 (a 6% annual rate of return).
I suspect that assumptions like this are why economists disagree with personal finance guidelines, and I suspect that the personal finance guidelines are more often correct about their assumptions than economists are.
If I had two buttons, to give me $1000 of consumption today, or $1001 of consumption in thirty years (inflation adjusted of course), I would press the second button.
This sounds nuts to me. Firstly, what about risk? You might be dead in 30 years. We might have moved to a different economy where money is worthless. You might personally not value money (or not value the kind of things you can get with money) as much. Admittedly there's also some upside risk, but it's clearly lower than the downside.
We're ignoring investment possibilities, of course. But even then, in any case, if you have £1000 now, you can use it to buy something that would last more than 30 years and benefit you over that time.
The risk is a good point given some of the uncertainties we’re dealing with right now. I’d estimate maybe 1% risk of those per year (more weighted towards the latter half of the time frame, but I’ll assume that it’s constant), so perhaps with a discounting rate of that it would need to be more like $1400. That’s still much less than the assumption.
Looking at my consumption right now, I objectively would not spend the $1000 on something that lasts for more than 30 years, so I believe that shouldn’t be relevant. To make this more direct, we could phrase it as something like “a $1000 vacation now or a $1400 vacation in 30 years”, though that ignores consumption offsetting.
ARMs make sense in theory, but I've heard that in practice the embedded interest rate option tends to be underpriced because homeowners don't always exercise when it would benefit them.
This econ paper about personal finance was featured in a recent Freakonomics Radio episode. It compares the financial advice in popular personal finance books with what economics research says is optimal financial behavior.
Some of the most surprising (to me) recommendations in the paper:
Pop personal finance advice is probably logistically and emotionally easier for the average person to implement than the recommendations of the econ literature, except for relatively simple ones like "don't overweight the U.S. market". For example, following a rule of thumb like saving 10% of your income every year is easier on the brain than figuring out how to smooth your consumption based on your current and projected future earnings. Morgan Housel, the personal finance writer who was interviewed for the Freakonomics episode, repeatedly stresses that, unlike the econ literature, the advice of popular finance books accounts for the fallibility of the human mind. However, if you're like me, you probably get peace of mind by doing the economically optimal thing, even if it's trickier. For those of us who value optimal personal finance strategy, following the recommendations of the econ literature might be worth the challenge.
In my opinion, a major reason why many people are not following the advice of economists is that economists don't spend enough time promoting the views of the field to the general public. This is true in the realm of public policy, where simplistic talking points crowd out expert opinion on many issues, but it's also true in personal finance. Personally, I was not even aware that the econ literature had many recommendations for personal finance other than the widely-publicized "invest in low-cost index funds". Even one personal finance podcast based on the results in the econ literature, simplified into heuristics that any person can follow, could help many people improve their finances.