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“Consumption smoothing” is a term used by economists to describe a consistent standard of living for an individual regardless of family size and the ebb and flow of non-discretionary expenses.  In other words, it enables you to maintain the same level of discretionary spending (i.e., consumption) while you’re raising a family, paying your mortgage, paying for college educations, when you become empty nesters and when you’re retired.  For reference, consumption smoothing is the subject of an excellent and easy-to-read book by Laurence Kotlikoff and Scott Burns entitled Spend ‘til the End. Consumption smoothing is mathematically complex and computationally intensive and is an extremely rare feature in retirement calculators, but Pralana’s Retirement Calculator can do it in a couple of seconds on a modern laptop computer. Armed with this powerful capability, you can raise your standard of living both now and when you retire! Please check out the graph to the right for an illustration of PRC’s consumption smoothing: the red line is the “smooth” consumption calculated by PRC despite wide variations in the other expense categories.

So, upon the click of a button associated with the Non-Specific Discretionary Spending table on the Other Expenses tab, PRC can automatically calculate the maximum constant (in current $) annual discretionary expense that can be supported within your plan for the rest of your life and your spouse's life.  Furthermore, PRC gives you control over the amount of conservatism to use while making its calculations:  You can select either "Live to 100", "Safe ROR" or "As Specified".  If you select "Live to 100", PRC will override the life expectancies you entered on the General tab and make its calculations assuming that you and your spouse both live to age 100.  If you select "Safe ROR", PRC will assume all your Savings and Retirement Accounts earn a conservative ROR that you specify.  If you select "As Specified", PRC will use all of your inputs as entered on prior tabs.  We provide you two important controls over this process, also defined in this table: 1) the percentage by which you want PRC to reduce the unallocated discretionary expense after the death of the first spouse and 2) if you have a line of credit, you can specify the maximum amount of indebtedness to incur in the course of this process. To carry the process to the maximum extent, you might want to put nothing in any of the other PRC expense tables except for what you consider to be truly non-discretionary expenses, then tell PRC to compute the maximum smooth discretionary expense that can be supported. A Monte Carlo simulation will then assess the probabilities of your money outlasting you. If you wish, you can manually decompose and allocate the computed value into specific expenses, enter them into one of the other tables and, finally, clear the entry from this table. Barring an unpredictable economic disaster of some sort, you could then spend the computed amount every year regardless of the ups and downs of your non-discretionary expenses (say, house payments and college educations) but there might be years where you spent or even took on some debt rather than contributed to your savings. 

Consumption Smoothing Example1

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