One of the most important pieces of advice when it comes to looking after your wealth is to be prepared with an emergency fund. This is an amount of money that you set aside to protect your financial independence (or progress towards it) in the case that some unexpected spend or loss of income happens. It's the money you use to deal with a financial emergency.
The amount you set aside could be £1,000, 6 whole months of living expenses, or maybe even more; it's really down to your personal preferences based on how you manage financial risks.
But is that all you need to do when it comes to being prepared for a financial emergency?
Well, it's certainly better than not having any money set aside but you can't always just throw money at a problem until it goes away. You'll either run out of money or you probably could have solved it without reducing your emergency fund so much if you were simply better prepared.
And what happens if you're unlucky enough to get hit by two or three financial emergencies in a short span of time? Maybe even at the same time?
The total amount you had in your emergency fund might get drained quicker than you expected and in such cases you'll wish you had been more efficient so that you could utilise the money to maximum effect in dealing with the issues.
But in order to be more efficient you pretty much need to know what you were going to do in the first place, rather than simply reacting as best as you can at that moment in time. This is why I believe everyone should take their preparations at least one step further beyond building an emergency fund by coming up, maintaining and periodically reviewing an action plan that is designed to help you handle various different types of financial emergencies.
I call this the FEAR Plan which stands for "Financial Emergency Action Readiness" and it is a clear set of steps that you will take when a financial emergency happens. There should be different steps to follow depending on the type of financial emergency, and the aim is to not become caught up or confused on what needs to be done under most circumstances.
Getting caught up and not knowing what you need to do next can cost you time and money, meaning the financial emergency is going to have a bigger impact on you in a negative way. Having a clear plan that you're familiar with will do the opposite and might even save you money since you already thought about the options available to you.
It's a bit like the regular fire drills at a school or office where the fire escape route, gathering location and headcounts are practiced regularly. If this wasn't done then there would be a lot of confusion if a real fire happened; nobody would know where to go or where to gather, and it would be hard to determine if anybody was still stuck inside. Having a plan makes it really clear on what needs to happen in order to minimise the loss.
Here is a table to highlight the cons of not having a plan in contrast to the pros of having a plan:
Make your list of Financial Emergencies
To get started with creating your FEAR plan you first need to understand what are the potential financial emergencies that you might have to deal with one day. The commonly thought of things such as a job loss or your car breaking down will be obvious things to place onto the list but it can also include specific situations or concerns that you personally feel is important to be prepared for.
Here's an example list with some of the things I consider to be financial emergencies:
For each emergency event I have also put an example estimated cost and an impact. The purpose of these two estimates is to help identify which financial emergencies are likely to have the biggest negative effects on your life; these are the ones where it's most important to have a clear and up-to-date action plan.
You could arguably get away with not really having much of a plan for something that's low impact, such as a dental emergency. If you know the number of the dentist and have some painkillers you should be able to get through it in most cases. But something like a litigation case isn't something you want to be unprepared for. You at least want to know which legal professionals you can rely on and some of the laws around a particular area so that you're not completely helpless.
The most obvious example is if you are a landlord. You want to know the laws and legal processes around tenancies just in case you end up with a bad tenant who won't pay and won't leave.
Notice how the estimated cost isn't always directly correlated to the impact. Litigation fees is estimated to cost the same as an Emergency home repair but the impact is far higher. This is because being entangled in some legal action can be extremely stressful and that in itself will make this financial emergency even more important to be prepared for, as already mentioned before.
How you categorise your financial emergencies is entirely up to you. You can use my method of estimated costs and impact or you could come up with your own thing. The key is to understand that not all financial emergencies are equal in nature and you'll need to plan appropriately based on these differences.
Creating your Action Plan
Now that you have a list it's time to start creating an action plan for each potential financial emergency. Be careful of writing too much "excess" in your plan just because you feel like you're "missing something" and you can't quite put your finger on it. If this happens, writing more usually isn't actually going to help and might even confuse things when you're trying to follow the plan for real.
Instead create a framework of questions or key points for your action plan that you know will cover all the areas that you feel are important. Follow this framework when writing all of your plans. Here's an example of a framework:
Give a brief description of what happened.
What are the short term things that can be done to improve the situation a little?
What needs to be done first? What needs to be done next?
Is there a professional or service that needs to be contacted?
Who are they and why are they listed? Back up options?
Is there any information that they need to be aware of?
Is time off work needed? How long?
What are the chances of time off work becoming prolonged?
Is assistance needed to look after dependents or pets?
What's the estimated cost overall and why?
Using a framework like this allows you to "story tell" your action plan for each financial emergency in a way that is succinct, so that it is easy to consume and understand, and detailed enough to cover all of the important things when familiarising yourself with the problem.
Take a look at the example below to get a better understanding:
There are two parts of the action plan, key steps and a story, and each has an important purpose.
The key steps are the boiled down things that need to be done to solve the financial emergency, and is designed so that you can read it quickly whenever needed. You can use it as a quick reminder when reviewing each of your action plans, and as a reference list to tick off when you're actually dealing with the financial emergency.
The story is a way for you to describe and work through the financial emergency, and by writing it down in this manner you are effectively imagining it happen for real. Your story must cover all of the key points and questions in your framework so that you know you are fully prepared with minimal chances for a surprise. It also gives you a chance to talk about the estimated costs involved, so you know if your emergency fund can reasonably cover this particular financial emergency.
Needless to say there'll always be a chance that you missed something as you can never know for certain what will happen in real life, but you can at least predict and pre-empt a large part of it to some degree of accuracy and confidence.
The biggest benefit is that you are simulating the event in your mind so that when it happens for real you'll have some sort of sense that you've already been through it. This could help you remain calmer and therefore more effective in dealing with it.
You'll also notice that the framework and action plan story covers some things that could be done to improve the situation in the short term. By doing this it can help you realise that some financial emergencies may not be as severe as you first thought.
If your boiler breaks down in the middle of winter you don't need to book the nearest hotel for the next 3 nights for example, you can simply take a few small steps to get you through the next few days until an engineer comes to fix your boiler.
The key to a good action plan is to keep it short enough that it isn't a chore to review and maintain, yet long enough so that it gives you a clear sense of the scenario and helps you develop a bit of mental preparation for when it does eventually happen.
Review, Adapt and Optimise
Once you've created your FEAR plan you don't want to leave it in the background until a financial emergency actually happens. Make sure to review it regularly so that you are familiar with your actions and reasoning as you don't want to be trying to refamiliarise yourself during the financial emergency and wondering why you came up with certain steps.
Reviewing your plan regularly also enforces your familiarity with each scenario. This only helps to increase your self-confidence in dealing with the issue. The best financial emergencies are the ones where you don't even feel like they're an emergency at all, just an inconvenience that requires a bit of your time and money to sort out.
Fortunately, financial emergencies should be rare as long as you're living life sensibly (I'll let you be the judge of what that means). It might therefore be enough for you to simply review the key steps of each of your action plans on a regular basis, once a month for example, to keep yourself familiar with the most important actions. You can then review the stories of each action plan every couple of months to get yourself thinking more deeply about each scenario and deciding if there are any improvements or adjustments needed.
Unfortunately, a financial emergency is pretty much inevitable for each and every one of us and there is going to be a day where it happens. The plus side is that you'll probably learn something from that event, regardless of if you had a plan or not. Use that experience to adapt and improve your FEAR plan so that it includes any extra actions or preparations that you feel would have made it easier for you to deal with.
One thing to keep in mind is that many of the lessons you learn from dealing with one type of financial emergency can often be applied in some variation to another type. The most prepared people will use this knowledge to make improvements to their other action plans after thinking about how an unfortunate event can be turned into an advantage for the future.
The more accurate your FEAR plan is the more confident you can be in the amount of money you have set aside to deal with a financial emergency. You might be able to reduce your emergency fund's size down by a few months based on your preparations and experience, and that would free the money up for you to do better things such as invest in growing your wealth.
Preparation is always the key when it comes to overcoming a challenge. The people who prepare the most for a big match, an exam, or any other important thing in life are usually the ones who will see the best results overall.
Yet strangely very few people do any real preparation for a financial emergency despite it having the potential to literally ruin their lives for a number of years to come.
In the cases where there is some "preparation" all it really means is that there is some money set aside just in case. How much they have set aside is usually based on some arbitrary standard and you'll have difficulty finding someone who truly understands why they have 6 months costs in an emergency fund.
More can and should be done.
There are numerous benefits to creating and maintaining a FEAR plan. It can reduce stress and anxiety during a financial emergency and can help you overcome the problem quicker, meaning you can get back to your normal life, as you have a pre-determined set of actions that you can follow. It can save you money as your actions are more optimal. And it means your emergency fund is easier to rebuild after you've dealt with the financial emergency as less money was used.
The more optimised your FEAR plan is, the more optimised your emergency fund can be. That leads to a more optimised plan for your personal finances and wealth, making your journey towards financial independence even clearer and maybe even easier.
My mission is to help people understand their money by making financial scenarios or concepts easy to understand.
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