Hatcher, 11(2)

Hatcher, C. B. (2000). Should households establish emergency funds? Financial Counseling and
Planning, 11
(2), 77-83.

Should Households Establish Emergency Funds?

Charles B. Hatcher1

This paper uses both an individual cost-benefit model and a deterministic simulation to investigate
whether or not households should sacrifice higher rates of return in more liquid and less volatile
investments in order to be prepared for a financial emergency. The cost of having an emergency
fund is the difference between the rate of return in an illiquid, volatile investment and the rate of
return in an emergency fund. The benefits of an emergency fund are the borrowing costs avoided
in an emergency. With reasonable assumptions about borrowing and lending rates, emergencies
would have to occur very frequently for an emergency fund to be optimal.

Key words:Emergency Funds, Liquidity, Risk

1. Charles B. Hatcher, Assistant Professor of Human Development and Family Studies and Assistant Professor, Economics, Iowa State University, 72 LeBaron Hall, Ames, IA 50011. Phone: 515-294-8889. Fax 515-294-1765. E-mail: chatcher@iastate.edu.

The author thanks Cynthia Needles Fletcher, Elizabeth Kiss, and the Iowa State Family Resource Management Extension Faculty for their helpful comments.