To make the most of your Income and Savings, it’s essential to become financially wise. Financial Wisdom will help you distinguish between good and bad advice and make intelligent Financial Decisions.
Personal Finance refers to the Knowledge, Instruments, and Techniques used to manage your finances.
When you understand the principles and concepts behind Personal Finance, you can manage Debt, Savings, Living Expenses, and Retirement Savings.
It encompasses Budgeting, Banking, Insurance, Mortgages, Investments, Retirement, Tax, and Estate Planning.
Key Points
- Money Management is almost never taught at school. Therefore, it is important to learn how to manage your Personal Finance through articles, courses, blogs, podcasts, and books. In this blog I will try to suggest as many as I can.
- The core areas of managing Personal Finance include Income, Spending, Savings, Investments and Protection.
- Smart Personal Finance involves developing strategies that include Budgeting, creating an Emergency Fund, paying off Debt, saving for Retirement, and much more.
- Being disciplined is important, but it’s also good to know when you shouldn’t adhere to the guidelines.
Personal Finance Goals
Personal Finance is about meeting your personal financial goals.
These goals could be anything: having enough money for short-term financial needs (a vacation, a new car, a wedding), planning for retirement, or saving for your child’s education. It depends on your Income, Spending, Saving, Investing and personal Protection (insurance and estate planning).
Not understanding how to manage finances or be financially disciplined can lead and has led many people to accumulate enormous debt – especially compared to their wealth and income. See here for a discussion about the difference between wealth and income.
American private households debt, for example, reached a staggering 16.900 billion USD at the end of 2022, compared to USA GDP (Gross Domestic Product, see here for a brief introduction to this key macroeconomic parameter) equal to 25.460 billion USD (see New York FED article, here).
This ever-increasing amount of debt is often “bad debt” (i.e. used to acquire liabilities, not to acquire asset). See here to learn more about assets and liabilities.
This makes managing personal finances more critical than ever, especially in periods in which inflation is eating away at purchasing power and prices are rising.
Areas of Personal Finance
The five areas of personal finance are Income, Saving, Spending, Investing and protection.
1. Income
Income is the starting point of Personal Finance.
Income is Cash Flow going into your pocket. Income is all the money you bring in: this includes salaries, wages, dividends, and other sources of cash inflow.
It is the entire amount of cash inflow that you receive and can allocate to Spending, Savings, Investments and Protection.
NOTE: Income and Wealth are two very different things. See here for further explanation.
2. Spending
Spending is Cash Flow going out from our pocket. Typically, this is where the bulk of our Income goes.
Spending is whatever an individual uses their Income to buy. This includes rent, mortgage, groceries, hobbies, eating out, home furnishings, home repairs, travel and entertainment.
Being able to manage Spending is a critical aspect of personal finance. Individuals must ensure their Spending is less than their Income; otherwise, they won’t have enough money to cover their expenses or will fall into debt. Debt can be devastating financially, particularly if high-interest rates apply (for example credit cards charge, common in America, much less in Europe).
3. Saving
Savings is the Income left over after Spending.
Savings = Income – Spendings (1)
Of course, in order to have savings, you must be able to live below your means (which means spending less than what you earn). It seems trivial, but it is not. Easy credit can be delusional: money seems easy to get, things seem easy to purchase… but debt (and especially bad debt) easily adds up, eating more and more of your income.
Everyone should aim to have savings to cover large expenses or emergencies. However, this means not using all your income, which can be difficult. Regardless of the difficulty, everyone should strive to have at least a portion of savings to meet any fluctuations in income and spending—somewhere between three and 12 months of expenses.
Beyond that, cash idling in a savings account becomes wasteful because it loses purchasing power to inflation over time. Instead, cash not tied up in an emergency or spending account should be placed in something that will help it maintain its value or grow, such as investments.
4. Investing
Investing involves purchasing assets, usually stocks and bonds, to earn a return on the money invested.
Investing aims to increase an individual’s wealth beyond the amount they invested. Investing does come with risks, as not all assets appreciate and can incur a loss.
Investing is a form of delayed gratification. I sacrifice short-term gratification (money I could spend today) to hopefully have a larger amount in the future (long-term gratification).
Investing can be difficult for those unfamiliar with it—it helps to dedicate some time to gain an understanding through readings and studying. If you don’t have time, you might benefit from hiring a professional to help you invest your money.
5. Protection
Protection refers to the methods people take to protect themselves from unexpected events, such as illnesses or accidents, and as a means to preserve wealth. Protection includes life and health insurance and estate and retirement planning.
Conclusions
This was a very introductory post about the fascinating, useful and incredibly vast topic that is Personal Finance.
Did this post catch your attention on this topic?
See next posts for General Personal Finance Strategies.
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