Published in: Credit Cards | Jan. 25, 2020

Why You Should Try a Financial Fire Drill

By:  Dana George

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We can all benefit from a trial run of what life might look like if our finances take a hit. 

None of us knows what the future will bring. It's impossible to know if you’ll lose a job, get sick, or end up "consciously uncoupling." What would happen to your financial situation if any of these worst-case scenarios were to happen? Simply put, the wrong time to figure out how you're going to get through an emergency is when you're in the middle of it.

To figure out how to get by in case of a future emergency, consider conducting a financial fire drill now. This involves creating a plan to cover your basic living expenses if you were to lose part or all of your income.

A young boy and a fireman practicing how to use a fire hose.

Image source: Getty Images

I like to be prepared for the worst. So, just as I keep an emergency ladder in every bedroom of my two-story home in case there’s ever a fire, I also conduct at least one financial fire drill every year. Be it a fire or a job loss, it’s all about preparing for an event I hope will never happen.

How to conduct a financial fire drill

The first part of a financial fire drill is determining how much you need in your emergency fund to cover everyday expenses in case of temporary income loss. To do this, figure out how much money you need to cover the basics. This means examining your expenses and cutting out anything you can possibly live without. For example:

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  • Meals out. In case of an emergency, you can shop smart and make all meals at home, keeping in mind that it's not forever.
  • Housing. Figure out how to minimize the cost of housing and make a plan for doing it, even if it means taking in a boarder, finding a roommate, or moving to a less expensive home. Remember to factor in utilities. If you live in a temperate area, it's easy to cut back on heating and cooling costs. 
  • Extras. This is where things can get tough. Cut cable, gym memberships, subscription services, hobbies, and other non-essentials. 

Say your "regular" monthly budget is $4,000, but after cutting all non-essentials, you bring that down to $3,000. That number tells you that you need to make sure to keep $9,000-$18,0000 ($3,000 x three to six months) in your emergency fund. If you feel as though that's cutting it too close, plan to take on a side hustle or create an alternative stream of revenue. 

Create an "if I'm gone" plan

The other part of an annual financial fire drill can be sobering. It assumes that the important people in your life will have no idea of what to do if you die. My "if I'm gone" plan includes making sure all of this information is in place:

  • Life insurance contact information and contract numbers
  • List of all retirement, investment, and savings accounts, including contact and account numbers
  • Letter reminding my person (or people) that the "everyday living" fire drill exists and where it can be found
  • Pre-paid funeral information
  • Reminder of where my will can be found
  • Information regarding my safe deposit box and what it contains
  • Passwords for my online financial accounts
  • Reminder of any other sources of income they may have forgotten, like book royalties and pensions
  • List of creditors -- including mortgage, car note, credit cards, and any remaining loans -- with contact and account numbers

Someone else needs to be able to take over if I'm incapacitated or die. If my husband and I both disappear while searching for Blackbeard's treasure, our sons need to be able to step in and take care of our financial matters. 

What to do with your fire drill results

Once I conduct a financial fire drill, I write up a financial emergency plan and share it with my husband. If you’re single, share your plan with someone you trust, agree on where you're going to keep your financial plan, and show them how to access the funds to pay your bills. Every year, conduct a new financial fire drill and make updates to your plan.

I normally don't make many changes during the "if I'm gone" part of the drill. Other than needing to add or delete sources of credit, very little changes from year to year. 

A little preparation can ease your mind

There's no sugar-coating it: Financial fire drills can be a bummer. It’s no fun to imagine your life without niceties like dining out or cable. And it makes you think about tough issues like what would happen to your money if you were to pass away.

As tough as it is to go through a financial fire drill ahead of time, doing so provides a blueprint to follow should your financial house ever go up in flames.

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