Finance is a rising field of Business sciences that continues to grow and become more and more popular in the Business World. However, its advantages are not only confined to the business world. In fact, out of the three types of finance, one particular field is dedicated just for you. The terminology used for this field is Personal Finance or Simple Finance. But before we delve into this field, it is essential to establish what we exactly mean by finance.
Finance is not just about knowing where your money was spent as is the common misconception. The field that caters for that is accounting and believe it or not, these two fields are quite different. Instead, finance actually asks the question why your money was spent there. Was it the right decision? Could it be made better?
Therefore, by now we can establish that finance is more about decision making based on your data of expenditures, or on the where part of the question. To sum it up in one line, finance is about making decisions on the accounting data that you have received. At the most basic level, this is how finance companies or departments work. They gather historical data in accounting terms and then utilize it to make decisions on future. But this article is more about you and luckily you don’t need the advance features that these companies use. Personal finance companies use the simpler concepts of finance to determine the finance based decisions that you can make. Personal Finance is then management of your money and resources to make insightful decisions that are most profitable for you.
Real Life Examples of Personal Finance
To understand better, let’s take an example. Ray has just received his pocket money, and this time, wants it to last longer than it did the last time. The first thing that he would want to do is to budget his money according to his presumed needs. The whole process of deciding where to spend your money and where not to is the very basis of personal finance.
But it doesn’t stop just there and we can still use Personal Finance in more than just managing our money. To continue with the example, say by now Ray has been so successful in budgeting his money that he has earned himself some savings. Up to the point that he has taken an interest in the investment business. Then the tools will become slightly more complicated than just simple finance. It will require him to check on data using tools such as the trend analysis, forecasting or what not. Hence, as you begin to accumulate more and more money, you also start to step higher and higher on the ladder of Personal Finance. At this stage, the lines between Corporate Finance and Personal Finance begin to blur as, now, you should start treating yourself as a finance company using tools that a finance manager would use. However, the tools and equations that you will be using are still related to simple finance. By now, we do know what Personal Finance is and how advantageous it can be if applied to our daily lives but the question remains so. How do we apply Personal Finance?
How to Integrate Finance in your daily life?
To integrate personal finance, you need to first determine the measures that you are going to use for doing personal finance. If your prime goal is to save money, like Ray, then keeping simple accounts of your expenditures and creating a budget on its basis is all that you need. However, even this part is not as easy as it looks. In fact, for me personally, it becomes quite a hectic task to remember all my transactions. Therefore, I’d suggest to always carry around a pen and a piece of paper. After that, you can choose whenever you want to record all your transactions up till that point. This will ensure that you keep a keen check on your budget and know exactly where your money is being spent and whether or not it should be. We can even move a step forward and predict exactly, how much should be spent in the future based on its average. In this way, you can give a more quantitative appeal to your insights than just qualitative.
When you’ve moved past that and have earned yourselves some savings, then now is the time you should start taking interest in investments. Investments can involve buying stocks, bonds, commodities or ForeX Trading or simply investing in banks. In the beginning, Ray might want to restrict himself to simpler modes of finance for example investing in banks, but as the time passes, he should start diversifying as this will increase his returns, or the profits he makes. A wise investor never puts all his money at one place, rather diversifies it and invest in different modes such as the ones mentioned above. At this point, Personal finance gets a little trickier and requires more professional tools and formulas. However, these formulas are still categorized as simple finance so you can expect to learn them pretty quickly. Luckily, there are many applications and software that Personal finance companies have introduced. These finance companies have built in formulas with the capacity to do these calculations for you. However, to understand better, you can learn more about these tools and formulas and create your own excel sheet with written formulas. For this, let’s take a brief look at the most commonly used formulas that are involved in personal finance and our used by different Personal Finance companies
Tools of Personal Finance
The tools for personal finance have been developed over time by different mathematicians and investors. These tools can guide you from the very beginning of your decision whether or not to invest to the point of diversifying your investments and making the most out of your investment. Here we will only look at the most commonly used investment methods stage by stage to equip you and Ray on their journey of using personal finance to make investments.
Calculating the Intrinsic Value
The first and foremost decision that Ray will have to make is whether or not to invest in a particular company, commodity or otherwise. For this, you need to understand how the stock prices work. Stock prices are actually more market based and varies according to the market demand. As the demand increases so does the price and vice versa. But for Ray, getting the most desired or popular shares will not do him any good as their prices will already be quite higher. Hence, in this matter, Personal finance guides to invest in shares that have a chance of rising in the future. In other words, the shares that are lesser in price due to lower demand but actually have a higher intrinsic value, or actual value, should be the prime concern of an investor.
Intrinsic value basically accumulates all the future returns that you can reap out of a company in its price. The thumb rule of investment here is that, if the intrinsic value of a stock or a share is lower from its original price, you should consider buying the shares and if the opposite case is true then you should definitely not buy the share. This is because an efficient market will quickly adjust to the intrinsic prices as the investors grow more and more aware. This concept is actually derived from corporate finance and is used widely in finance companies to determine whether or not to invest in different projects. In Personal finance, however, the concept has been adjusted so that it fits better in the category of simple finance so you can still use these concepts in your life to make most out of your investments.
Hence, if Ray were to buy stocks that had a lower intrinsic value than the actual market price, chances are that in the upcoming years, that share will get reduced to its intrinsic value. Thus, now the same shares that Ray had bought for, say $1000 dollars might get worth of only eight $800 dollars. In the opposite case, if Ray uses the tools to invest in shares with a higher intrinsic price, soon the market will adjust according to it. Hence, let’s say Ray invests in shares for a $1000 dollars that are actually worth $1500 dollars. As more and more people buy these shares for their lower price, the market demand will push the prices of the same shares to $1500 dollars. At that point, if Ray were to sell his shares, he will make a profit of $500 dollars, hence making his very first profit. Therefore, by just doing some simple calculations, you too can stay ahead of the market and make more and more profit out of it.
You might be thinking that making $500 dollars by doing just a few mathematical calculations is a pretty sweet deal, but, what if I were to tell you that there is still more you can make by doing only a few more calculations? This another tool of simple finance explains just how Ray and you can do that.
Investing your money in just one entity might seem like a safe choice. It’s also easier to manage that investment and seem a little less complicated. But the truth is, that by investing in only one company, one type of bonds or one type of any mode of finance for that matter puts you and your resources at a dire risk. What if your calculations were wrong, or if not that, what if the company suddenly got hit by financial crisis? There are always only a few factors that you can control while the factors of macro environment at large will always be there to make or break your investment. So what can we do when all our calculations, research and tools can be rendered useless by even the smallest factors of macro environment?
Ever heard of the saying, “Don’t put all your eggs in one basket?”, this is exactly what a wise investor does in situations like these. When a macro environment factor is at work, there are always winners and losers in the market. What an investor should do is to play on both sides. Then, even if one of his investments are lost, they’ll be compensated, too much extent, from his other investment. This process of diversifying your investments is known as Portfolio Diversification or Portfolio analysis. This concept again has been derived from finance companies. However, the finance companies use it at a more complex level. Hence, by simplifying this concept of finance investors all over the world are making an active use of this tool.
To clarify let’s again take the example of Ray. Say Ray, after reading this article, decided to diversify his portfolio. He decided, that for now he will be diversifying his investment into two segments, shares and ForEx. Let’s say that the US dollar, for some reason, has devalued in comparison to Euro. This will have a negative impact on the company shares specially if that company depends on importing from UK. Hence, the once lucrative market shares, might decrease in value overnight. Had Ray invested all his savings in that particular company shares, he would have faced a severe loss but due to diversification, there is still a silver lining in this state of crisis for Ray. What happened here is, that due to the devaluation of the US currency, the Euros that Ray holds are now of more value. Therefore, by simple diversification, Ray was able to protect his investments from ever getting lost.
And there are a number of different tools other than these, such as trend analysis, calculating amortization, portfolio returns and what not that are there to guide you. However, it is completely understandable if learning all these tools can be a havoc. Luckily, many Personal Finance companies incorporated all these formulas and developed applications making it even more easier for you.
Therefore, if you want to use Personal Finance to manage your money and resources, then following applications can help you do so;
For Managing Investments
- SigFig Wealth Management
- Personal Capital
Other than that, Personal Finance companies also act as a consulting firm. These companies provide you expert opinions and guides you to use your money wisely. In this way, you can even start using personal finance without having to learn any of the tools. However, it is always a plus to have a knowledge about these tools as they will provide you with more insights than otherwise.
Don’t worry if you find it difficult to go through all these tools by yourself. It is quite understandable for a person with no prior knowledge of finance to use these tools. Personal Finance companies have also introduced the concept of Personal Finance Class. These classes help you understand the basic knowledge that you need to equip yourself with to use the financial tools. Hence, before starting to invest, you should start attending Personal Finance classes that can help you in your journey. Personal finance companies introduce these to help investors learn from the basics to the professional tools of Personal finance and therefore, new investors should specially consider attending these classes.
Many of these Personal finance classes are available online and therefore, you can attend these classes from anywhere you want at any time you want and equip yourself with the knowledge you need. However, Personal Finance classes can only teach you the tools of personal finance. The trick is to apply these tools correctly at the right time. Hence, while using personal finance for investments, it is very important to learn from your mistakes. Therefore, in this field of finance, your biggest teacher will be experience itself.
Hence, all in all, there are a number of advantages that you can get from inducing personal finance in your lives and the journey just keeps going on. Although these tools are normally categorized as simple finance tools, they are so powerful in nature that several investors have made quite a hefty amount over it. From simple management of your pocket money to getting rich quick, personal finance can better organize your life and help you achieve your goals quicker. And while there are a number of tools that you can use to maximize investments, many applications are there to make your journey even more simpler. If you want to go beyond the norm and involve yourself directly with investments, you should then consider attending online Personal Finance classes as they will help you understand the core elements of personal finance. However, your biggest teach will always be your experience. Now all you need to do is to start managing your pocket money today and see how simple budgeting might make you the next Ray Dalio, the boy who started investing when he was only twelve from his savings to the man who became one of the richest people in the world just by using personal finance as a part of his life.