Finance, in simplest of terms, can be defined as the management of the money. When we talk about the management of money, it means, how to use money effectively and efficiently, minimizing the wastage and optimizing the resources. Financial management tells us how to invest, how to spend, how to save, how to lend, how to borrow. Finance is further divided into 3 main types which include Public, corporate and personal finance. Personal finance is probably the most important of all. How? It includes every single person, a layman, an employee, labor, a shopkeeper, and a very long list. (optional introduction)
Personal finance, as it is related to individuals, can be described as managing one’s individual/personal activities related to finance. How to manage it effectively and efficiently is basically the core idea behind personal financial management. Corporate finance and public finance are managed by highly skilled professionals but managing personal finance is more complex and important as not everyone can afford to hire a financial consultant.
To understand personal finance, one must comprehend its basics. Understanding and learning personal finance is one of the most important factors in personal finance management. If you don’t know the basics of managing personal finance or you do not understand personal finance and its importance, then, surely there is no point in managing it in an effective and optimizing way. This guide will help you develop an understanding of personal finance and will make it easier to learn personal finance
Now, there are five basic areas which cover the category of personal finance. These include saving, protection or security, investing activities, expenses or spending activities, and most importantly, income. Income (personal finance sources) is arguably the most important ingredient in this entire process. Let’s discuss these five factors briefly and start with personal finance sources.
Income (personal finance sources):
Personal finance sources refer to the activities that are responsible for generating the cash inflow or it is also called the generation of revenue. An individual then spends this income on various activities that will be discussed next. It is the first and most important step in making a financial plan for personal finance. Common personal finance sources are
- Returns on investments (dividends)
- Interest received (bonds)
- Profits from personal business (sole proprietor)
- Profits from a partnership
- Subsidiaries, loans, rebates, lotteries, prize bonds (uncommon sources)
Spending includes all the expenses that an individual incurs. That may include buying goods, getting services, or anything that can be consumed. There can be confusion between expenses and investment. Expenses are consumed or used assets or income while investments are those assets that will be benefitting you in the future. Some common ways of spending include Food, rents, utility bills, taxes, travel expenses, entertainment, loan repayments, interests on loans, college or university fees, different maintenance charges, fuel, and so on.
Spending everything that you have earned is not a wise strategy at all. Just think about the following things. What will happen if you suffer losses in the future? What if you lose your job? What if your business is hit by losses? What if there is no return on investments this year?. There must be a backup or contingency plan. This can be achieved by putting some portion of your personal finance resources (income) to savings. Savings can be in the form of cash, liquid assets (assets readily convertible into cash), saving bank accounts, etc.
If there is a surplus after deducting your expenses from your income than the next step after savings should be investing. Investing should be considered after savings because savings are very secured as compared to investments. Although saving accounts can also produce profits but the rate or ratio of return on investments is always higher. Investments are slightly less secured as compared to savings but they are highly rewarding tools. You can invest in shares, bonds, real estate, mutual funds, public and private companies, commodities, etc. Investing is a bit tricky and complicated process and it needs proper knowledge and guidance.
Security measures (protection):
Everything needs protection in case there are hiccups. There can be unexpected or abrupt events that can affect your financial plan. Health issues or losses incurred to your property or assets can cause you and finances huge trouble. So, getting health insurance, life insurance, vehicle insurance, property (real estate) insurance can be a very effective activity.
These five areas helped us to understand personal finance. Let’s discuss a few strategies that can help you manage your personal finance sources (income) in a better way .
Create a budget:
Create a fixed portion or a budget for your finance sources (income). It will be helpful for meeting your current expenses as well as saving for contingencies and other purposes like retirement plans, investments, loans, and interest repayments. Now, the question arises that what should be the ideal ratio for budgeting your personal finance. Most financial specialists advocate the 50/30/20 budgeting method.
50% of your income goes towards fulfilling basic essentials for living, such as utilities, traveling, groceries, school/college fees, etc. 30% of your income goes to luxuries or expenditures related to lifestyle, such as clothing, dining out, trips, entertainment. 20% of your income goes to your future plans, such as loan or interest repayment, retirement funds, contingencies, insurances, investments, etc.
Managing your budget can be a hard thing and keeping track of your expenditures can be even harder. There are apps for personal budgeting that can help you with it. They keep a record of your expenses and keep you updated about it so you can make necessary adjustments. Not only this, but they also entertain you with tips and suggestions related to budget management.
As mentioned above, some portion of your income should go to your “contingency fund”. For example, expenses like bills related to medical payment, damage to your car or property, a loss in any financial venture, loss in investment or personal business, or you might even face unemployment for a time being, etc. These hiccups need to be dealt with properly managed financial plans. Therefore, saving a portion of your personal income for these issues is a highly recommended activity.
Limiting your debts:
Keep yourself away from debts and loans may sound simple but it is not. You might have to take a loan from an institute or a friend from time to time. It can be a profitable activity if that loan is utilized to acquire another asset which will benefit you in the future. You might also be thinking to buy a house or a car with the help of a loan and it can be termed as a good move. But, how about renting or leasing a house? Isn’t a better idea? But how? Let’s assume, you take a loan to buy a house and you will have to pay interest as well as the original amount in the future. But, if you rent a house then you just have to pay monthly rent which can be managed easily.
Manage credit cards:
Credits card may be an enticing and urging tool but it should be kept in check. Credits cards are a need of the hour and it has its own perks as well. It can also help you to keep a record of your spending which is very helpful in managing your financial activities. Paying your credit card bills regularly on time can help you keep things in check and you can enjoy the benefits of using a credit card with ease. One other way to combat this issue is by using a debit card. One of the biggest advantages of using a debit card is that you can avoid the amount of interest you have to pay on credit cards.
Investing some of your surplus personal finance sources can be a very profitable activity. You can invest in stocks, bonds, real estate or mutual funds, etc. The best thing about investing in these tools is they keep generating income as well as you can withdraw your investment at any time. Return on these stocks is high as compared to bonds but bonds are considered as a more secure investment than stocks so a mixture of both can be a better strategy.
On the other hand, there are other options for investing even if you don’t have enough money to invest. How? you can take a loan and then invest that money in shares or bonds. You can pay the interest on a loan from the income generated by return on those shares or bonds. The ratio of interest paid on loans is mostly lower as compared to the return on shares or bonds. So pay your interest and keep the “change” in your pocket.
One other advantage of doing this is if you invest in shares of successful and growing companies then you can get a return on investment and you can sell those shares at higher prices. Sounds interesting?
When you are young, retirement seems like a very distant destiny. But, it comes a lot sooner than that. Experts say that almost 80% of the current salary is needed for most individuals in their retirements to meet up the expenses. So, in order to make your post-retirement life happy, you might want to start as soon as possible. There are benefits of that, one, you can enjoy the perks of compounding interest if you start as early as possible. Two, you can get tax relief if you are putting that money in schemes like individual retirement account (IRA), a 401(k), or a 403(b).
See, it is not that difficult to understand personal finance. Let’s sum up all the discussion like this
- Do not spend all you earn.
- Create and manage a budget.
- Put some money for contingencies.
- Make an account for “savings”.
- Invest your surplus in revenue-generating activities.
- Keep your retirement in your mind.
- Increase your personal finance sources.
.This guide was prepared so that you can understand personal finance with ease and manage your personal finance and personal finance sources effectively and smartly. A smart and well managed personal finance strategy can make your life and retirement very satisfactory and pleasing.