Finance for Beginners: The Basics of Personal Finance

As highlighted in our first-ever post, there are three types of finance, depending on who they relate to. We’re taking a deep dive into the one type that everyone encounters and partake in every once in a while. Rich or poor, young or old, you will be faced with personal finance issues and elements often, if not every day. That said, reference the article above for more introductory information. Without further ado, let’s take finance personal! (Pun intended.)

What is Personal Finance?

Typically, money matters are seen as commercial or a ‘social science’ at best. However, in practice, personal finance is both art and science. You need both strategic and creative ways to tackle various issues as highlighted below.

Issues in Personal Finance

One’s personal finance concerns can be broken down into the following key issues:

1. Making Money: Often summarised by the term ‘income’ this is the individual’s concern with generating an inflow of money. Effective personal finance management starts with an awareness of one’s income. The main strategy element here is earning.

2. Spending Money: Spending involves the outflow of cash for necessary and discretionary expenses. Effective spending management ensures that your expenditure does not exceed your income, thereby avoiding debt and financial stress.

3. Keeping Money: Once income is generated and you start using it to meet your needs and wants, the next step is to ensure that you don’t simply let it go mindlessly. The main strategies here are budgeting and saving.

4. Growing Money: Growing your money involves investing in assets such as stocks, bonds, and real estate to generate returns. Investing can increase wealth over time, but it requires understanding and managing risks. Practices like saving and investing are key here.

5. Protecting Money: Protecting money involves implementing robust security measures to safeguard financial assets from theft, fraud, and cyberattacks. This includes using strong, unique passwords for online banking and financial accounts, enabling two-factor authentication, and regularly monitoring account activity for any suspicious transactions. Additionally, staying informed about the latest cybersecurity threats and employing reputable security software can help mitigate risks and protect personal financial information.

Key Components of Personal Finance

To effectively manage personal finance, it is essential to focus on the following key components:

• Earning

• Spending

• Budgeting

• Saving

• Managing Debt

Why is Personal Finance Important?

Individual goals and desires, along with a plan to fulfill those needs within your financial constraints, also impact how you approach personal finance. Becoming financially savvy is crucial to making the most of your income and savings. This knowledge will help you distinguish between good and bad financial advice and empower you to make intelligent financial decisions.

• Financial stability and independence: Proper management of personal finance ensures you have enough money to meet your needs, leading to financial stability and independence.

• Avoiding debt and financial pitfalls: Understanding personal finance helps you avoid unnecessary debts and financial pitfalls.

• Preparing for emergencies and future goals: Good personal finance management helps you prepare for unexpected emergencies and future goals like retirement or your child's education.

Not understanding how to manage finances or being financially undisciplined has led many to accumulate enormous debt. For instance, in February 2024, the Federal Reserve Bank reported household debt had increased by $3.4 trillion since December 2019, prior to the recession. Various balances increased from the third quarter of 2023 to the fourth, including credit card balances, auto loans, consumer loans, and mortgages. (As gotten from Taxmann.)

Americans are taking on an ever-increasing amount of debt to finance purchases, making managing personal finances more critical than ever, especially when inflation is eating away at purchasing power and prices are rising.

Who Should Learn About Personal Finance?

For anyone looking to improve their financial situation, regardless of current financial status, learning about personal finance can help you make better financial decisions.

• Students: Learning the basics of personal finance early can set the foundation for a financially stable future.

• Working professionals: Proper financial management can help working professionals achieve their financial goals and prepare for retirement.

• Retirees: Understanding personal finance ensures retirees can manage their savings effectively without running out of funds.

When to Start Managing Personal Finances?

• Starting early is important: The earlier you start managing your personal finances, the better off you will be in the long run.

• Toward financial milestones: College, first job, marriage, and retirement are key milestones where financial management becomes crucial.

• Adapting to life changes: Personal finance is a lifelong journey that requires continuous learning and adaptation to life changes.

Basic Concepts of Personal Finance

Income or earning

Income is the starting point of personal finance. It is the entire amount of cash inflow that you receive and can allocate to expenses, savings, investments, and protection. Income is all the money you bring in, including salaries, wages, dividends, and other sources of cash inflow.

Spending

Spending is an outflow of cash and typically where the bulk of income goes. It includes rent, mortgage, groceries, hobbies, eating out, home furnishings, home repairs, travel, and entertainment. Managing spending is crucial as individuals must ensure their spending is less than their income to avoid falling into debt.

Saving

Savings is the income left over after spending. Everyone should aim to have savings to cover large expenses or emergencies. It's recommended to save somewhere between three and 12 months of expenses. Beyond that, cash not tied up in an emergency or spending account should be placed in investments to maintain its value or grow.

Investing

Investing involves purchasing assets, usually stocks and bonds, to earn a return on the money invested. The goal is to increase wealth beyond the initial investment. Investing comes with risks, but dedicating time to gain an understanding or hiring a professional can help mitigate these risks.

Liabilities

Loans and borrowings used to buy assets create liabilities. While loans for appreciating assets can add to long-term wealth, leveraging to buy financial assets is risky due to price volatility.

Assets

• Physical Assets: Tangible items like real estate and precious metals. They are often seen as natural hedges against inflation but come with drawbacks like illiquidity and the need for specific skills in managing them.

• Financial Assets: Include bank deposits, equity shares, and bonds. These are standardized, regulated, and can be liquid or illiquid. They allow for smaller, more manageable investments.

Financial Strength

The financial strength of a household depends on how assets are acquired. Assets bought with savings and without liabilities add to financial stability. Conversely, assets bought with loans add liabilities and repayment obligations, which can weaken financial stability.

Conclusion

In summary, smart personal finance involves:

• Developing strategies for budgeting, creating an emergency fund, paying off debt, and saving for retirement.

• Using credit cards wisely and knowing when to deviate from strict financial guidelines.

• Continuously learning and adapting to new financial challenges and changes.

Understanding personal finance involves mastering the core areas of income, spending, savings, investments, and protection. Few schools offer courses on managing money, making self-education through online articles, courses, blogs, podcasts, or books crucial.

By mastering the basics of personal finance, you can achieve financial stability and independence, avoid debt, and prepare for future goals and emergencies. Whether you're a beginner or looking to improve your financial literacy, understanding personal finance is a lifelong journey that requires continuous learning and adaptation.