Personal Finance: What Is Personal Finance?
- 8 min read
- Personal finance is all about the money you have, the money you earn, and the money you hope to have in the future.
- A personal financial plan involves budgeting, banking, saving, investing, insuring, borrowing, paying taxes, and protecting your credit rating.
- Understanding personal finance can help you meet your current needs and future goals.
What is personal finance? Like it or not, managing your personal finances is one of the most important jobs you have. That’s true whether you struggle to make ends meet or actively manage investment accounts.
If you don’t feel entirely comfortable with the job, you’re not alone. A study by the FINRA Investor Education Foundation found that 60% of Americans from the ages of 21 to 62 said thinking about their finances made them anxious.
A lot of times, what scares people is the unknown. Personal finance is such a big subject that it’s hard for the average person to feel they understand it all. However, you don’t have to be an expert to take care of the basics. This article reviews the fundamentals of personal finance. If you become a little more familiar with what’s involved, you can start to become more comfortable with the subject.
Definition: What Is Personal Finance?
Personal finance involves every aspect of how individuals handle their money. This includes everything from how you’re going to pay for the groceries tomorrow to how you should save for retirement.
This article introduces some of the basics of personal finance:
- Retirement Planning
The goal is to help you understand how each of these enters into your personal finances. Also, this article explains how you can get professional help for these different functions.
Budgeting means having a plan for your household finances. That involves looking ahead to where your money comes from and how you’ll spend it.
Obviously, one element of budgeting is making sure you’ll have enough money coming in to cover your expenses. Another big part of budgeting is timing. It’s important to plan things so that money becomes available before bills come due.
Budgeting is a way of making sure you meet immediate living expenses, but it should go beyond that. Some portion of your budget should be dedicated to saving money.
This includes saving some money in an emergency fund. This helps you keep your budget on target when unexpected expenses arise.
You should also be budgeting some longer-term savings. Budgeting savings for things like the down payment on a house or your retirement helps make sure that money is there when you need it.
Finally, an important part of budgeting is monitoring. Making a plan is just a start. You then need to check regularly to see whether the plan is on target and make adjustments when things change.
Keeping up with your taxes is an important personal finance responsibility. If you earn money, you will probably owe federal taxes. In most states, you’ll also owe state taxes, and in some cities, you may owe local taxes as well.
To some extent, paying taxes happens automatically. Employers withhold a certain amount from each paycheck, based on what you expect to earn that year.
Nevertheless, you are still responsible for filing your income taxes. In most cases, the deadline is April 15 for the prior tax year.
Even if you’ve had taxes withheld throughout the year, you have to file a tax return. If you don’t file your taxes on time, penalties for failing to file or failing to pay may kick in. The penalty is based on the amount owed. However, if you file 60 or more days late, you’ll pay a minimum penalty of either 100% of the tax due or $435, whichever is less. Not filing can also affect your eligibility for certain government programs.
Handling your taxes is a little more complicated if you’re a freelancer or self-employed. In that case, taxes aren’t automatically withheld from your pay. So, you’d need to keep a reserve to pay taxes on what you owe. You may be required to make quarterly estimated tax payments in addition to filing a return at the end of the year.
Savings play a key role in personal finance because that’s how you get ahead financially. Living paycheck to paycheck is stressful. Having goals and saving to meet them helps you afford things that can improve your way of life in the future
A good way to build savings is to start by thinking short-term, and then plan ahead from there.
As a first step, start putting money towards an emergency fund. This means having about six months’ worth of essential expenses built up to draw on in case of a financial setback.
Next, think about major needs that will come up in the years ahead. Things like your next car, a downpayment on a house or your kids’ education. Expenses like these are all more affordable if you save up for them over time rather than have to deal with them all at once.
The ultimate long-term expense most people need to save for is retirement.
That leaves quite a gap. Unless you belong to a pension plan – which is increasingly rare these days – you’ll need to fill that gap with your own savings.
Now think about how long you may live in retirement. To fill the income gap over many years of retirement takes a lot of savings. That’s why it’s important to save for retirement throughout your career, and not just when you’re nearing retirement age.
Fortunately, many employers administer 401(k) plans that help you save for retirement. These plans can save you money at tax time, and often employers will match some of what you put into the plan.
Even if your employer doesn’t have a retirement plan, there are retirement accounts like IRAs that you can set up through a bank or brokerage firm. These also have tax advantages.
Ultimately, how much you put aside for retirement is up to you. There are a variety of retirement calculators you can use to estimate how much money you’ll need to support yourself in retirement. It’s a good idea to estimate your retirement needs early in your career, so you can have plenty of time to work towards that goal.
When you save money for fairly short-term needs like emergencies, it’s important to keep the money safe and available. Often a bank savings account is the best choice for that. When you start thinking long-term though, investing in growth securities becomes necessary.
Investing helps your money grow to meet future needs. It’s very difficult to accumulate enough money to retire on just by savings alone. Investing can provide some growth to enhance the impact of your savings.
When it comes to long-term needs, investing is also important to try to keep up with inflation. Rising prices reduce the purchasing power of your money. This has the greatest impact over long time periods.
The necessity of thinking beyond savings accounts to keep up with inflation is shown by this comparison as of the end of 2021: while inflation for the year was 7%, the average savings account was yielding just 0.06%. That means the interest on a typical savings account that year was less than a hundredth of the rate of inflation.
Growth can come from a variety of instruments - conventional ones like stocks and bonds as well as new and purely speculative instruments like cryptocurrencies and NFTs.
Along with growth potential comes risk, so investing takes great care. Fortunately, there are thousands of professionally managed funds available that allow you to invest without having to become an expert. Still, always remember that the risk is still there. Even professionally managed funds often lose money.
Besides managing the money you have, part of personal finance involves borrowing responsibly when the situation calls for it.
In fact, borrowing money can cost you in three ways:
- Interest charges on the amount you owe increase how much you’ll have to pay back. In fact, on longer-term loans like mortgages, interest payments often add up to more than the initial principal.
- Fees, such as line of credit maintenance fees or mortgage origination charges add to the direct cost of borrowing.
- Loan payments reduce the amount of your money available for savings.
Before you borrow, always plan for repayment and make sure that you can afford the loan. Also, compare rates and fees before you sign up for any type of credit. Smart shopping can reduce the price you pay for borrowing money.
Get Personal Finance Help Based on Your Needs
This article is just an introduction to the various aspects of personal finance, but you can see there’s a lot to it. Fortunately, there’s also a lot of help available.
A variety of online resources can make it easy to compare rates and fees on products like bank accounts, credit cards, and loans.
Investment firms and independent sites provide information to research possible investments. There are also plenty of mutual funds, managed accounts, and other products that can invest your money for you.
Financial planners can help you with basic tasks like budgeting and building a retirement nest egg.
Finally, if your household finances get into difficulty, there are services like debt counseling and debt relief services that can help you find a way out of the hole.
Should I pay off my loans before I start saving for retirement?
Certainly, you should always keep up with your required loan payments. As for accelerating those payments to pay off what you owe faster, a lot of this depends on your specific situation.
If you get an employer match on contributions to a retirement plan, it’s often better to keep making those contributions rather than extra loan payments. Otherwise, with high-interest debt like credit card balances, you’ll probably save more by paying it off faster than you’d earn by investing the money.
Should I steer clear of investing in stocks if I don’t like taking risks?
Part of being risk-averse is understanding all the different forms risk comes in. People think of risk only in terms of losing money, which is certainly a possibility when you invest in stocks. However, there is also the risk of inflation growing faster than your money and eating up your savings. So, combining different types of investments is a good approach to handling different types of risk.
Will I get a better deal if I get a car loan from the bank where I keep my savings account?
Never assume that your current bank is the best choice. Always shop around first to make sure. If your bank wants to give you a discount on a car loan for being a savings account customer, then great. That will help them offer a more competitive rate, but you should still look around to see if someone else has an even better one.