Optimal savings liquidation for income replacement in the presence of income uncertainty
DOI:
https://doi.org/10.61190/fsr.v16i4.4897Keywords:
Financial advising, Emergency fund, Personal savingAbstract
The decision to liquidate savings for debt repayment is an important one that most consumers face at some time. Traditional financial analysis of this liquidation decision merely compares the interest paid on the debt to the interest earned on the savings, resulting in an almost universal recommendation to liquidate. This paper proposes that savings valuation should include a financial asset that has not previously been explicitly valued: an income replacement option. Applying an option valuation framework to the savings liquidation decision dramatically reduces the number of situations where liquidation is a proper strategy, particularly as income volatility increases.
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