What is Personal Finance?
Personal finance is the act of planning and managing personal financial activities. It involves income generation, spending, saving, investing, as well as protection. Thus, Managing one’s personal finances can be summed up in a budget or financial plan.
Areas of Personal Finance
Here, I will be breaking down personal finance. I will explore each of them in more detail to help you have a more direct understanding of the topic. The main areas of personal finance are income, spending, saving, investing, and protection.
Income
Firstly, Income means a source of cash inflow that an individual receives and then uses to support themselves and their family. Income is the starting point of the financial planning process.
Common sources of income include:
- Salaries
- Bonuses
- Hourly wages
- Pensions
- Dividends
All these sources of income all generate cash that an individual can use to either spend, save, or invest.
Spending
Secondly, spending, This includes all kinds of expenses an individual. It includes buying goods and services or anything that is consumable. Also, all spending can be categorized into two groups: cash (paid for with cash on hand) and credit (paid for by borrowing the money). Note that majority of most people’s income is allocated to spending.
Common sources of spending are:
- Rent
- Mortgage payments
- Taxes
- Food
- Entertainment
- Travel
- Credit card payments
The above-listed expenses all reduce the amount of cash an individual has available for saving and investing. Where expenses are greater than income, the individual has a deficit. So managing expenses is just as important as generating income. Usually, people have more control over their discretionary expenses than their income. On the whole, good spending habits are critical for good personal finance management.
Saving
Saving means excess cash that is retained for future investing or spending. Where there is a surplus between what a person earns as income and what they spend, the difference can be directed towards savings or investments. Managing savings is a vital area of personal finance.
Common forms of savings include:
- Physical cash
- Savings bank account
- Checking bank account
- Money market securities
In addition, most people keep at least some savings in order to manage their cash flow. Also, the short term difference between their income and expenses. However having too many savings, can be said to be a bad thing, as it earns little to no return as compared to investments.
Investing
In the same vein, Investing relates to the purchase of assets which are expected to generate a rate of return. The individual aims at receiving back more money than they originally invested. Investing comes with risk. Because not all assets actually end up becoming a productive positive rate of return. This is where the relationship between risk and return comes in.
Common forms of investing includes:
- Real estate
- Art
- Bonds
- Stocks
- Mutual funds
- Private companies
- Commodities
Investing happens to be one of the most complicated areas of personal finance. It is one of the areas where people get the most professional advice. There are enormous differences in risk and reward between different investments. As a result, most people seek help with this area of their financial plan.
Protection
Furthermore, Personal protection. This is to a vast range of products which can be used to guard against an unforeseen and adverse event:
Common protection products include:
- Life insurance
- Health insurance
- Lastly, Estate planning
Protection happens to be another area of personal finance where people typically seek professional advice and which can become quite complicated.
Personal Finance Principles
Moreso, It is of utmost importance to state that personal circumstances differ considerably, depending on patterns of income, wealth, and consumption needs. Tax and finance also differ from country to country, and market conditions also vary geographically and over time. So what applies to one person may not apply to another. But according to the University of Chicago professor Harold Pollack and personal finance writer Helaine Olen argue that in the United States good personal finance advice boils down to a few simple points:
- Firstly, You are to pay off your credit card balance every month in a full month.
- Save up to 20% of your income
- Try to maximize contributions to tax-advantaged funds like 401(K) retirement funds, individual retirement accounts, and 529 education savings plans.
- Lastly, When investing savings:
Don’t try to trade individual securities.
Avoid high-fee and activity managed funds.
Scout for low-cost, diversified mutual funds that balance risk Vs. reward appropriately to your target retirement year.
As earlier stated, the limits stated bylaws may differ in each country.
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