INDONESIAKININEWS.COM - Managing your personal finances involves managing both short- and long-term aspects of your finances. It also refer...
But, if you’re new to personal finance, all that may not mean much to you. So, let’s explain why personal finance is important, its five areas, and its fundamental principles.
Why is Personal Finance Important?
Financial planning is important for managing your day-to-day needs as well as ensuring your financial security in the future. Generally, people who spend more than they earn or their entire income don’t feel insecure and anxious when their retirement period approaches, but they will feel insecure when they reach retirement.
According to a Mind over Money survey by Capital One and The Decision Lab, more than three in four Americans (77%) worry about their financial future. There are a variety of financial concerns, from saving for retirement to paying for a home or education for your child.
In terms of financial concerns, Americans are most concerned about not having enough money for retirement (68%), keeping up with the cost of living (56%), and managing debt levels (45%).
According to respondents, financial stress impacts all aspects of Americans’ lives, causing fatigue (43%), difficulty concentrating at work (42%), and trouble sleeping (41%). And, about a quarter of respondents (25%) said their relationships were affected by financial stress.
The purpose of personal finance planning is to handle your finances effectively and to meet your financial goals while making sure that your future is secure.
In personal finance, all aspects of finances are considered, including:
- Budgeting
- Debt
- Estate Planning
- Insurance
- Investments
- Social Security
- Retirement
- Risk Management
- Taxes
- Wealth Management
To live a healthy, happy, and secure life, it is crucial to have basic financial skills. It can make a difference between prosperity or poverty in your life if you understand the fundamentals of budgeting, saving, debt, and investing.
What are the Five Areas of Personal Finance?
Despite the fact that personal finances cover a wide range of topics, they can all be categorized into five broad categories: income, spending, savings, investing, and protection. After all, developing your financial plan is all about these five things.
1. Income
A person’s income refers to the amount of money they receive and use to support themselves and their families. As such, the process of financial planning begins here.
There are a variety of income sources, including:
- Earned income. For most people, this is their primary source of income, aka their day job. People typically rely on this source of income for the majority of their income. Regardless of whether you’re paid hourly or salary, you’re trading your time for money.
- Business income. You’re a business owner. There are two ways to earn a living: you can make and sell things or you can provide services.
- Interest income. You earn this income by lending out your money. The money could come from a CD, P2P lending, real estate crowdfunding, fix-and-flip debt deals, or simply a savings account.
- Dividend income. In this case, it refers to money you receive if you own company shares.
- Rental income. You own something that you rent out. Renting apartments for monthly payments is probably the most common way to own a rental property. However, you could rent out a room on Airbnb or your vehicle on Turo.
- Capital gains. The money you earn when you sell an investment, such as stocks, is called capital gains.
- Royalties/licensing. Someone uses your product, idea, or process. Every time they do, they pay you a small fee.
An individual can use each of these sources of income to spend, save, or invest the cash they generate. As such, income can be considered the first step in our personal finance roadmap.
2. Spending
Any expense that is related to buying goods and services or anything consumable (e.g., not an investment) can be considered spending. There are two categories of spending: cash (purchased with cash on hand) and credit (purchased with borrowed funds).
Typically, spending accounts for a significant portion of most people’s income.
According to the U.S. Bureau of Labor Statistics, here are the percentages of what the average American spends each month.
- Housing — 33.8%
- Transportation — 16.4%
- Food — 12.4%
- Personal insurance and pensions — 11.8%
- Healthcare — 8.1%
- Entertainment — 5.3%
- Cash contributions — 3.6%
- Apparel and services — 2.6%
- Education — 1.8%
Overall, for good personal finance management, you need good spending habits.
3. Saving
Saving is reserving excess cash for any future investments or consumption. You can save or invest the difference between your income and your spending if you have a surplus.
In addition to short-term goals like an emergency fund, savings accounts can also be used to stash away cash for long-term goals like a down payment. The most common types of savings accounts include:
- Traditional savings accounts. When you think about where to save, you may immediately think of traditional savings accounts. Typically, you can find these accounts at traditional banks and credit unions.
- High-yield savings accounts. The majority of these can be found at online banks, neobanks, and credit unions. In comparison to regular savings accounts, they offer a higher annual percentage yield. Your money will grow faster with this type of savings account.
- Money market accounts. A money market account (MMA) combines the features of a savings account and a checking account. They’re available at brick-and-mortar banks, online banks, and credit unions.
- CD account. Your money stays in the account for a set amount of time with certificates of deposit (CDs). As your money earns interest, you can either withdraw your savings or roll them into another CD when it matures. Due to a time factor, these accounts aren’t like other types of savings accounts.
- Cash management account. In contrast to other savings accounts, cash management accounts aren’t designed specifically for saving. This type of account lets you hold cash that you may invest in a retirement account or a taxable brokerage account in the future.
- Specialty savings accounts. Rather than serving as a catch-all for the money you won’t spend, these are designed to help you meet specific savings goals. Sometimes they aren’t intended for savings, but rather for a specific type of person.
4. Investing
Investing involves buying assets whose return is expected to be high, with the hope of receiving more money in the future than was initially invested. There’s risk involved with investing, and not all assets produce positive returns. This is where risk and return meet.
Investing can take many forms, including:
- Stocks
- Bonds
- Mutual funds
- Exchange-Traded Funds (ETFs)
- Retirement Plans, such as 401(k)s and IRAs
- Annuities
- Real Estate
- Private Companies
- Commodities, like metals or agriculture
- Art
The most complex area of personal finance is investing. So, it’s no surprise that this is where professional advice is most sought. Investments differ greatly in risk and reward, which is why most people seek professional advice.
5. Protection
In terms of personal protection, there are a wide variety of products that can be used in order to shield against unexpected and adverse events.
Among the most common protection products are:
- Life Insurance
- Health Insurance
- Estate Planning
Often, people seek professional advice in this area of personal finance, as it can become quite complex. In order to properly assess an individual’s insurance needs and estate planning needs, a lot of analysis is required.
What are the Fundamental Principles of Personal Finance?
The Jump$tart Coalition for Personal Financial Literacy is a Washington DC-based organization that promotes teaching personal finance to young people. A long time ago in a galaxy far, far away, Jump$tart Coalition published a list of 12 personal finance principles that anyone can benefit from.
Here are a few quick descriptions of each principle:
1. Know Your Take-Home (Net) Pay
Consider how much income will be left over after all mandatory deductions before making significant expenditures, such as credit card debt, car loans, or a mortgage.
2. Pay Yourself First
Make sure you keep an affordable amount aside every month for long-range goals and unexpected emergencies, rather than paying bills and other obligations every month.
3. Start Saving Young
You can increase your savings by both earning interest on savings and saving over a longer period of time. To put it another way, you should begin saving for your future as soon as you can. The more you save, the more interest you’ll earn.
4. Compare Interest Rates
Find out what rates are available at different financial services firms, so you can make the most informed decision. The same is true when you take out loans or lines of credit as well.
5. Don’t Borrow What You Can’t Repay
You’ll be more likely to be approved for credit if you’re a responsible borrower. With that said, take a look at your total payment obligations and the income you’ll have to cover them before you borrow.
6. Budget Your Money
Prepare an annual budget based on your income and expenses. Think of a budget as your roadmap for building your savings and living within your means — as opposed to thinking that budget is a filthy word.
7. Money Doubles By “The Rule of 72″
Divide the interest rate by 72 to find the length of time it will take for your money to double. A 72-year account earning 6% interest, for example, will double in 12 years.
8. High Returns Equal High Risks
When you invest in something that has a high return on investment, you’re likely to take on more risk. But, when you diversify your investments, you reduce your investments’ risk.
9. Don’t Expect Something for Nothing
Any financial offer that promises free investment returns or a guaranteed return on investment should be avoided. A lot of times, if something sounds too good to be true, it probably is.
10. Map Your Financial Future
Prepare a list of both short-term and long-term financial goals. Then create a realistic road map to reach your goals.
11. Your Credit Past Is Your Credit Future
You should be aware that credit bureaus maintain credit reports, which record borrowers’ repayment history. If your credit report contains negative information, you may have difficulty borrowing in the future.
12. Stay Insured
An illness or accident can wipe you out financially, which is why you should purchase insurance. Every individual should have an insurance plan as part of their financial planning.
Source: entrepreneur
