Think back to when you were in elementary school and the school called a fire drill.
The purpose was clear: It was to prepare you for what to do if a real fire occurred.
The same type of preventive action needs to take place with your finances. Conducting a "financial fire drill" could save your finances from being scalded in a crisis.
"In the chaos and confusion of a real fire, most people panic, making their situation much worse," said Tom Murphy, certified financial planner at Murphy & Sylvest in Dallas. "Planning and practicing fire drills in advance allows you to act wisely without having to think in difficult situations. Similarly, a financial fire drill will help you make good decisions in the event of a financial emergency."
The most common financial emergency is a large unexpected expense, such as your car dying, the air conditioning breaking down or needing a new roof, he said. A job loss or a large unexpected medical bill also falls into that category.
"Whenever any of these types of events occur, you will need to make decisions almost immediately," Murphy said. "Do you have the money to pay for a new car, air conditioner or roof without using a high-interest credit card? How long can you go without a paycheck? What changes in lifestyle will you have to make if you are unable to return to work?"
A financial fire drill not only tests whether you have the money to withstand a crisis, but also whether you can put your hands on the information you'd need at an urgent time.
Here are key areas to test:
If you lost your job, how much would your monthly minimum survival expenses be? And knowing that, how long would your savings last?
"Do you have a fund for emergencies equal to at least three months?" Murphy asked. "How long can you take to look for a job before you have to make radical changes to your spending? What is the minimum compensation you have to receive in a new job to maintain your standard of living?"
Looking at the bare-bones minimum you need to survive isn't the same as tracking your spending, said Rick Salmeron, certified financial planner at the Salmeron Financial Network in Dallas.
"Instead, it is the opposite," he said. "You are measuring how much you can avoid spending on food, shelter, utilities and the like and still get by. We're talking thinner than bare-bones minimum expenditures. You must adopt a temporarily ruthless state of mind here."
Do you have a will, a financial power of attorney, health care power of attorney and a living will?
If you do, do you know where the documents are? Do the key people in your life — your loved ones, your doctor, lawyer and financial advisers — have copies?
"If you ended up in the emergency room of a hospital after an accident, whom could they call to get your insurance information?" Murphy said. "Do you have an 'in case of emergency' listing in the contacts of your phone?"
June Werry knows how important those documents are.
Her first husband didn't have a will when he died in 1993. Her second husband, who died in 2011, didn't have a will when they married.
That proved particularly problematic because her husband, a real estate broker, owned 36 homes that he rented out. They talked about drawing up end-of-life documents and eventually did.
"We had talked about it, but you think this stuff is not going to happen, that at the age of 50 is not when you're going to die," said Werry, an administrative assistant.
Having those documents eased the transition after her second husband's death.
"If you don't have a will, you're crazy," she said. "I don't care what age you are, because you never know when something's going to happen."
She said people also should be sure to get several copies of the death certificate after their loved one dies. That proved necessary for Werry because her name wasn't on the mortgages on the homes her husband owned.
"I had all these mortgage companies that I had to deal with," Werry said. "They didn't want to talk to me because my name wasn't on the mortgages, so I had to send them death certificates, letters of testamentary — a court document stating that you're an estate's legal executor. Before he died, I had to have a power of attorney in order to talk to some of the mortgage companies."
If you have dependents, how would they fare if you were no longer around to bring in income?
"Sometimes we think about the death of a spouse and we think, 'This is what I'm going to do' and you in your mind plan what life is going to be like for you," Werry said. "Then the death occurs and it is nothing like what you had envisioned. You don't realize how traumatic it's going to be on you. You have to take a look at the fact that you've got to replace the income from the spouse who has left."
Although her first husband died without a will, he did have life insurance.
"If you've got young children at home, you need to have income replacement until that child is 18," Werry said.
Her second husband also had life insurance, but his medical bills forced the couple to tap the death benefits early.
Many life insurance policies allow a policy holder to receive the benefits before death. Such "accelerated benefits" are normally reserved for those who suffer from a terminal illness, have a long-term, high-cost illness, require permanent nursing home care or have a medically incapacitating condition.
The accelerated benefit is deducted from the benefit that will be paid to the beneficiary after the insured person's death.
"We had taken an early disbursement of most of it, so there wasn't a whole lot at the time of death," Werry said.
"Approximately one-third of all retirements in any given year are involuntary, and a significant percentage is as a result of illness of yourself or a loved one," Murphy said. "Although recovery and getting back to work is an excellent goal, you must plan for the possibility it might not happen."
Have an honest conversation with your doctor about the probability of full recovery, he said.
"Quickly calculate what annual income you will be able to generate from your retirement plans, investments, Social Security and any other sources, and adjust your spending accordingly," Murphy said.
Doing all these things may save your finances from being burned in a "financial fire."
"When faced with personal disaster, many freeze, making the problem exponentially worse," Murphy said.