James Choi - Yale School of Management
Practical Finance: An Approximate Solution to Life-Cycle Portfolio Choice*
James J. Choi (Yale University and NBER)
Canyao Liu (Hudson River Trading)
Pengcheng Liu (Yale University)
Research on normative household financial choices almost always gives guidance in one of two
forms: a simple formula for an unrealistic setting, or a numerical solution for a particular set of
parameters in a realistic setting. Neither is very useful for individuals trying to figure out optimal
choices for their own situation. We propose a middle-ground approach, which we call practical
finance: approximations to optimal solutions in realistic settings that are easily computed in a
spreadsheet. We provide such an approximation for lifecycle portfolio choice with non-tradable
labor income within the canonical Cocco, Gomes, and Maenhout (2005) model. Across 2,187
different parameter sets, our approximation results in welfare that is on average only 0.02% lower than that of the optimal solution.