Uncertain economic times have increased the value of smart personal finance decisions. Each year, above a million Americans lose billions of dollars in fraudulent investments or declare bankruptcy. On the other hand, the breathtaking pace of banking evolution shows no sign of slowing down.
What could be the best solution to fend off the financial challenges and live a better life?
It all depends on your ability to make wise money decisions for your long-term financial well-being.
And, to do this, you should have a strong knowledge of personal finance.
This guide will cover all the important areas of individual financial management to help you better manage your finances.
What Is Personal Finance?
Personal finance refers to realizing individual financial goals, planning, and managing money to accomplish those goals within your financial constraints. It involves expenses, living requirements, income generation, investing, savings, planning for retirement, insurance, mortgages, tax, and estate. The process of managing your personal finances requires a budget or a financial plan to attain long-term economic satisfaction.
The Emergence of Personal Finance
Personal finance was only a part of the consumer sciences about 200 years back with less attention from mainstream business faculty and monetary experts. In 2006, finance scholar Campbell coined the phrase ‘household finance’ to encourage the inclusion of this chief topic into the comprehensive study of finance on institutional grounds.
Since then, many finance scholars and economists put personal finance as a part of the broader finance discipline. With the burgeoning interest, the institute of Financial Counselling and Planning (FCP) set the stage for researchers in the mid-1980s to generate knowledge, publish information, and provide research programs on personal finance topics.
Today, personal finance is a broad area of study. You will find many informative articles, journals, and research papers online to educate Individuals to make the most of their income and savings.
This guide also serves as an educational resource to provide information about personal finance basics and help you make savvy decisions.
Core Areas of Personal Finance
Just as a company’s finances boil down to a few fundamental principles, so too is personal finance. You should have the financial literacy to manage your personal finance as it affects your life on a daily basis.
According to John W. Rogers, Jr., CEO Ariel Capital Management, “Financial literacy is just as important in life as the other basics.”
In this guide, we will break down five core competencies for personal financial literacy issued by the United States Department of Treasury in late 2010, so you can have extensive knowledge of the topic.
Below are the details of five main areas of personal finance, which include:
- Income – how you earn money
- Spending – how to use money wisely
- Saving- how to keep money
- Investing – how to maximize the money
- Protection – how you save financial assets for retirement
Income includes calculating how much a person earns and uses the cash inflow to pay taxes, fees, or support their family. It refers to the difference between gross versus net pay and an understanding of investments in education to boost future earnings potential.
It is the starting point of the personal financial planning process in which common streams of income include:
- Earned Income (monthly salary, yearly bonus, or hourly wages)
- Business Income
- Interest Income (real estate crowdfunding, money in a savings account)
- Dividend Income (owning shares of a company)
- Rental Income
- Capital Gains (stocks)
Spending covers all forms of expenses an individual incurs connected to purchasing goods for living or anything that is not considered an investment. It means distinguishing between your needs and wants, creating and maintaining a budget, abnormal spending behavior, and its impact on the future. Spending can be of two types, cash, and credits.
Personal finance experts categorize expenses as fixed and discretionary spending.
Fixed expenses – It refers to a fixed amount of spending per month, such as:
- Mortgage/ rent
- Home loans/student/car loans
- Credit card payments
Discretionary spending – It includes expenses that change every month, such as:
- Food/eating at restaurants
All these expenses minimize the cash inflow, and if the net value of spending is greater than income, the individual will have a deficit. To avoid this situation, managing expenses with good spending habits are vital for good personal finance management.
Savings include smart ways to hoard money for uninvited financial emergencies. It means managing the cash flow and the difference between income and expenses. It refers to the fund you make for your emergency needs out of your income and expenses.
Savings is a surplus between what a person earns and what they spend. Managing savings is a complicated and most important area of personal finance. It includes understanding checking and savings accounts, emergency funds, long term investment options, retirement planning, tax savings, or using monetary products wisely to see long-term goals.
Common forms of savings include:
- Bank account (saving or checking)
- Emergency funds
- Tax deductions through section 80C and 80D
- 529 College savings plan
It is the fourth most complicated area of personal finance in which people get professional advice. It is related to using credits to purchase assets that generate a rate of return. It means receiving back more money than invested originally to maximize income for the future. Investing involves risk as all assets will not end up making a considerable rate of return. It is a connection between uncertainty and reward, and that’s where counseling from a professional financial advisor is imperative.
Investing requires financial literacy of how loans work, how risky is the investment (credit score), evaluations of housing options, home mortgages, stocks, and cryptocurrencies.
Some common forms of investments include:
- Real estate
- Mutual funds/short term debt funds/Large Cap Funds
- Building retirement corpus like life insurance, EPF, NPS, STP withdrawal
- Financial Protection
The crucial part of personal finance management is protecting an individual’s assets from identity theft, fraud, or creditor claims. It can be done with proper analysis of investment plans, monitoring credit cards, assessing estate planning, and using strategies to protect your wealth from seizure or taxation.
To turn your dreams into reality, you must protect your assets with a safety net that will later turn into a liability. You can evaluate it legally without engaging in fraudulent transfer, tax evasion, or bankruptcy scam.
Protection of assets include:
- Life insurance
- Health insurance
- Mortgage protection insurance
- Real Estate planning
- Retirement Plans
- Holding digital currencies
- Personal accidental insurance
Examples Of Personal Finance
Personal finance examples include balancing a checkbook, obtaining funds for major purchases, taxation plans, or purchasing insurance.
It is to sit down with your spouse and plan out spending for kids’ education fees, saving for a fixed deposit on a house, paying off the debt from surgery, or prioritizing your goals.
All areas of personal finance can be wrapped into your financial goals. It can be short-term or long-term financial goals. And, to achieve your monetary goals, you need to create a budget. It will help you deal with all other areas of personal finances.
You can use personal finance software or a small notebook to keep track of your income and expenses.
Financial planning or budget will help you successfully handle your finances.
Identifying your objective, your cash flow, your capital, family security, the standard of living, elaborating your plan, execution of the plan, and re-evaluation are all examples of personal finances.