“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 several 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.
With PRC, you can specify whether you want the consumption smoothing algorithm to use the fixed rate, Monte Carlo or historical analysis mode. Each mode has specific strengths and weaknesses but, together, they offer unprecedented capabilities for understanding the amount of margin in your financial plan and for establishing a sustainable maximum standard of living regardless of market performance.
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