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Conduct a Financial Fire Drill

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Station Fire over La Canada FlintridgeThink back to elementary school, can you remember how many times your school had a fire drill? They were never announced ahead of time, the bells just rang, everyone got up, lined up, and left the building in an orderly fashion. Everyone knew what they were supposed to do because it was scripted ahead of time. No one panicked because we always assumed it was a drill, even when it wasn’t. (which puzzles me why all of my employers pre-announced rare fire drills)

When was the last time you had a financial fire? Maybe the car broke down or you broke a window in your house. Maybe you were one of the many millions who lost your job last year. I bet, in most cases, you weren’t sure what to do afterwards.

That’s why I’m recommending that you conduct a financial fire drill.

How to Conduct a Financial Fire Drill

The first step is to list all the potential “fires” you could have, including an actual fire in your home. Some common ones are job loss, car problems, fire or flood in the home, burglary of your house or home, and minor and major medical emergencies. Everything you thought of when you set your emergency fund is in play here.

Next, you need to setup a response plan and a financial plan.

Response Plan

The response plan is the series of steps you’ll take to respond to the emergency. In the case of job loss, you might want to list steps like signing up for job websites, updating and listing your resume, reaching out to your network of contacts in the industry, and filing for unemployment. If there are any steps you can do today, such as registering for job websites, do them because it will make your life easier later.

You want to write down your response plan now, rather than when you’re emotionally charged, because it’s easier to think clearly about it now. What’s easier: finding a job or helping a friend find a job? Most people would say helping a friend. Helping someone find a job is easier in part because you’re less emotionally invested in the income. While you’d love to find your friend a job, the consequences are less severe if you fail.

Financial Plan

Setting up your financial plan is a lot like setting up your emergency fund but doesn’t stop there. First, you need to establish how much you need to save. Take stock of how much the fire will cost you and save money into an emergency fund to handle it. For a job loss, you can save 12 months of expenses to handle an extended period of unemployment. For a car accident, save enough to cover the deductible.

Then, for each of the potential fires, link your response to the financial plan and be sure to include a recovery plan. I’ll include a few examples afterwards but the important part of this step is to try to take “thinking” out of the equation. If you have a CD ladder, include instructions on how you want to liquidate the CDs, in what order, and how you’ll want to get your ladder rebuilt.

Example: Car Repairs

Here’s a sample response and financial plan for a typical scenario – a car repair.

Response Plan for Car Repair

  1. Get repair quotes from at least two reputable mechanics (only one is necessary if you have a mechanic you’ve worked with and trust) in the area.
  2. Try to negotiate the repair price down or personally buying the parts required.
  3. If the repair is more than half the value of the car, consider selling or donating it and buying a new (to me) car.
  4. If the repair is less than $500, pay through savings or with a credit card (assuming the $500 can be repaid before the grace period ends). If the repair is greater, begin liquidating CDs starting with the shortest original maturity period (6 months is best, since the penalty will usually be only 3 months compared to 6 months on a 12-month CD) and lowest interest rate.
  5. Bring the car in and schedule a ride to work with a friend (or get quotes and rent a car).
  6. Redirect monthly savings away from another goal to replenishing the emergency fund.

Financial Plan

Most of the numbers used are example figures used to illustrate the idea of these plans.

Deciding how much to save. My car is a 2003 Toyota Celica and we don’t anticipate major repairs on the vehicle because it’s not at the age, or mileage, where major repairs are expected. That being said, a $500 repair would be significant and so we’ve decided to set an emergency fund allocation of $500 to cover a car repair scenario. We save an extra $42 a month into the emergency fund for a year to cover this.

Our emergency fund is much larger, $2,500 a month, to cover the whole gamut of potential issues (most notably, the mortgage in case of a job loss or a major medical emergency). Our emergency fund is saved up in a CD ladder, with one rung sitting in a high yield savings account. Should we have a car accident under $3,000, we would pay for it on a credit card for the points and then pay off the credit card from savings.

Why Should I Conduct A Financial Fire Drill?

Why is this important? If you’ve ever been fired, and I have, then you know what it feels like. It’s like someone punching you in the stomach and knocking the wind out of you. It doesn’t feel good. When that pain subsides, you start feeling the pressure of having to find another job.

Having to “figure out” how to find another job is really difficult when you have to deal with all the emotional aspects of losing one. If you’ve planned ahead of time, then you can go through the steps without having to “figure it out.” This takes the thinking process out of the equation and just lets you work on executing it.

The response plan can also help you make decisions dispassionately. In the heat of the moment, your judgment might be clouded by a variety of factors. When you’re sitting at home, with a job, with a working car, and without the pressure of an emergency weighing on your mind, you can make better informed decisions. Putting those decisions on paper can give you guidance when a real emergency happens.

The response plan can help others make decisions for you if you’re incapacitated. Anytime you write down the decisions you’ve made in your head, you empower others to act on your behalf if you cannot. You should put your fire drill response plan next to the list of all your bank accounts so that if someone else needs to handle your finances, they know what to do. Without guidance, they’ll use their own judgment which will invariably be different than yours.

Have you conducted financial fire drills and put together response plans? If so, I’d love to hear your thoughts in the comments below.

(Photo: mbtrama)

{ 14 comments, please add your thoughts now! }

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14 Responses to “Conduct a Financial Fire Drill”

  1. joruva says:

    The recent market panic made me question the large amounts I was choosing to invest (I have a conservative bonds equal my age strategy), but the idea of losing a large portion of my savings is pretty terrifying.

    My response plan is a tax loss harvesting (TLH) strategy for many of my index funds should we head for Recession 2.0. For example, I could sell exchange shares of Vanguard S&P500 (VFINX) into Vanguard Total Stock Market (VTSMX). After 31 days I would exchange back. Since the funds are highly correlated I would have roughly the same diversification. And if the market were to make a quick recovery I would still be invested.

    It doesn’t work out perfectly for every fund, but it does reduce my investment fears. Unfortunately you can’t TLH in 401k or Roth IRA, but at least those funds have 40+ years before the funds are needed.

  2. Having an emergency response plan is a very important piece of the financial plan – I think it’s foundational really.

    Planning for the unexpected and being ready helps save a lot of time, stress and money. Great post!

  3. I definitely think it is a good idea for people to plan out what they would do in a financial emergency. It is much better to make your plan while you are not in the middle of the chaos.

  4. Anthony says:

    This is one of the best (read “most unique”) PF articles I have read in a while.

    This certainly has gotten my blood flowing and my brain ticking away. I still have debts and still trying to build my emergency fund, but I could be fired tomorrow… What do I do then?

    Good article, Jim!

  5. zapeta says:

    I think its a great idea to make a plan before you are confronted with a situation where you have to make quick decisions under stress.

    I’m going to take a look at my finances tonight and see what a fire drill will tell me.

  6. Caitlin says:

    What a fantastic idea! I bet lots of people have emergency plans, but forgot about the financial aspects of the plans. I’ll have to run one of these drill son my own finances.

    No one panicked because we always assumed it was a drill, even when it wasn’t. (which puzzles me why all of my employers pre-announced rare fire drills)

    This is because we can trust 8 year olds to not panic and do what they are supposed to do during a fire drill; we can’t trust Average Joe Adult to do the same these days, unfortunately. There’s always someone that takes “I’m an adult, you can’t tell me what to do” way too far and would end up endangering others because they didn’t do what they were supposed to do (or panicked) during a drill. Talk about liability.

  7. Neil says:

    “(which puzzles me why all of my employers pre-announced rare fire drills)”
    Wow. If an employer pre-announces a fire drill here, it doesn’t count towards their required two per year, and exposes them to substantial liability if anyone is injured in a real fire.

    The whole point of random fire drills is the hope that in the event of a real fire, people will assume that it’s a drill and leave in an orderly fashion instead of panicking. Preannouncing is just plain stupid.

  8. These are some really great points! Definitely some things here that I need to think about.

    Also, I’m a teacher and we have had SO MANY fire drills this year. Plus, we just had the “intruder in the building” drill as well. 😉

  9. Diana says:

    Very nice post, definately what we should think about at least a few times a year!

    However, for me, getting fired wasn’t a blow. It was a relief! It was literally like having a weight lifted. I didn’t know that phrase related to an actual feeling until then. I would have been better off to have had a plan in place at the time…but I have learned quite a lot since then.

    Thanks for all your great work!

  10. Wojciech says:

    Awesome post! Especially in the current economy, it’s good to have a plan of action for just about anything.

    My wife always remarks that we should “live in the present” and stop worrying about the future. Well, IMO this isn’t worrying–it’s simply planning for something that might happen–which ironically, removes most of the worry.

    I’ll be getting started writing a few of my own plans later this afternoon! 🙂

  11. Peter says:

    Great idea – In a way we did this when we set up our financial plan, and started saving for our 8 month emergency fund. We’ve saved up enough money to cover us in any number of scenarios. Job loss, health issues, etc. We’ve already had a couple of those scenarios happen (medical emergencies) and having the plan was invaluable.

    Having the financial fire drill means you’re being pro-active, not reactive. That’s the way it should be.

  12. kitty says:

    I wouldn’t say car repairs is equal to fire. Car repairs is more like what to do if you burned your dinner. A fire equivalent of a financial emergency would be a loss of a job in a really bad economy like today when people are unemployed for a while. Or even a serious medical emergency.

    Stock market crash is another “fire” if you have your non-retirement money invested: would you need to sell, would you have enough in cash/CDs, if you have to sell after the crash, will you still be OK?

    @joruva: “I have a conservative bonds equal my age strategy”
    One thing to keep in mind is that bonds aren’t the same as CDs. As badmoneyadvice recently mentioned, it depends what bonds you are talking about. Junk bonds carry as much risk as stocks. Investment grade corporate bonds carry default risk as well as interest rate risk.

    For some reason when people talk of diversification, they only think stocks and bonds (as in bond index comprised of a whole bunch of corporate bonds). There are other asset classes out there – real estate, commodities, individual treasury notes and bonds, I-bond, TIPs, CDs and cash. As with everything you get lower return with lower risk, but surely if you want to diversify you need to at least think of other asset classes.

  13. Chris says:

    My family did this together and it helped us figure out ways to tie up loose ends like not having flood insurance on our home.

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