What is personal finance?
The term personal finance can be defined as the act of personal financial management best practices. It encompasses all the strategies that one uses to manage and account for all their personal finances to achieve both short-term and long-term financial goals. Personal finance involves managing your finances through budgeting, savings and investments, insurance, retirement planning, mortgages, emergency funds, tax, and effective estate planning.
Why is personal finance important?
When you understand how to manage your finances, you will have an easier time budgeting for your daily financial needs and at the same time set aside enough money to guarantee you long-term financial security. For you to achieve financial freedom, you need to make smart personal finance decisions by setting realistic short-term and long-term financial goals that align with your current income.
What are the 5 elements of personal finance?
Personal finance planning is made up of several key components that define how one plans his/her finances. They include;
- Income- Refers to all sources of cash inflows that one receives either from earning a salary, bonus, wages, pensions, dividends, social security, or rental/investment income. An income forms the foundation of your personal finance planning. Without a source of income, it’s not possible to budget and plan your finances.
- Spending- Spending refers to all the types of expenses that one incurs when acquiring or benefiting from the use of goods and services either for the short or long-term period. Spending is grouped as either cash where money is spent instantly or credit where debt is accrued to be cleared at a later date. Common forms of personal spending include; buying food, paying taxes, rent, entertainment, travel, mortgage, and credit card payments.
- Savings- Savings refers to the difference between what one earns and what is spent. The surplus cash is used either for future spending, savings, or investment. Savings in personal finance takes different shapes including; bank account, checking account, physical cash, or investing in money market securities.
- Investing- Investing is where an individual purchases a short-term or long-term property or asset with the hope that it will generate future returns. Investing requires proper planning of personal finances and an understanding of market dynamics in order to minimize investment risks. For most investments, the higher the rate of return, the higher the risk. Common investment vehicles where most individuals invest their finances for both short and long-term goals include; stocks, bonds, mutual funds, real estate, and private equity. Getting professional advice when it comes to making investment decisions is one of the best personal finance practices.
- Protection- This aspect of personal finance deals with personal and family protection against unforeseen circumstances in life. Common aspects of protection against unforeseen financial risks are done through taking health insurance, life insurance, property insurance, estate planning, and other measures that minimize any unexpected financial threats. Professional advice is also needed in making protection decisions as there are significant potential risks for every decision made.
What are the common personal finance principles?
For a successful personal finance planning, everyone must adhere to the following are guiding principles;
- Understand your income levels from your various sources
- Start spending your income by paying yourself first
- The earlier you start saving the better
- Always compare the interest rates of various financial products before making a saving or credit decision
- Create a budget that will guide you on what percentage of your income goes to savings, expenses, protection, and investments
- When investing, the higher the risks, the higher the returns
- Never borrow what you can’t manage to repay as it will affect your credit score