Personal finance is a topic with which we should all be familiar. And yet, too many people fail to address it at all. Perhaps it’s this society’s ingrained aversion to discussions surrounding money, or maybe it’s just abject denial. Either way, failing to grasp the concept can set you up for a lot of difficulties. After all, pretty much everything in contemporary life revolves around the main components of personal finance.
What is Personal Finance?
At its core, the term encompasses managing your money, saving it and investing it. Expanded, personal finance also incorporates budgeting, banking, insurance, mortgages, investments and retirement planning, as well as tax and estate planning. In short, anything to do with the money you have and the money you’ll need falls into the category of personal finance.
The key to managing your personal finances is developing and executing a plan for achieving your monetary goals. This can range from ensuring that you have enough money to enjoying a comfortable retirement to buying that flat screen you want — without going into debt to get it.
Above all, it’s about the proper handling of these four main components.
1. Spending/Expenses
This one underpins all the rest in that it is a huge determinant of how much of your income you’ll have available to save and invest when all is said and done. Most people who experience finance problems spend aimlessly. They live right out to — and often beyond — the edge of their incomes.
The most effective means for accomplishing this is establishing a spending plan — and sticking to it. Yes, we said spending plan, in that it is a guide for how you will spend your money to get the most benefit from it.
While some people also refer to this as budgeting, that word implies confinement. A spending plan connotes a sense of freedom. After all, you’re free to use your money however you’d like, as long you understand you’ll have to live with the consequences of exercising that freedom.
2. Credit/Debt
Debt basically comes in two varieties — good debt and bad debt. Good debt is a financial obligation you take on to improve your financial situation. Borrowing money to start a business is an example of this. Taking out a home loan or a student loan — both of which have the potential to improve your financial situation — are examples of good debt.
Bad debt is that which is incurred for a personal indulgence and/or the acquisition of a depreciating asset. Bad debt is also typically the culprit when people live beyond their means. It’s easy to whip out a piece of plastic and say “charge it” without thinking through the ramifications of that spending.
You’ll pay interest on those charges, and in some cases you’ll even pay interest on that interest. These factors can also fuel debt problems that might require professional help from a company like Freedom Debt Relief to resolve.
Moreover, carrying debt can have a negative impact on your creditworthiness. Too much credit card debt could knock you out of the running for getting a mortgage or a car loan to buy a vehicle to help you get back and forth to work.
It is also important to keep an eye on your credit history. Errors can creep into credit reports, also making it difficult to qualify for a loan you could use to better your situation. Scammers are out there too, trying to take advantage of your good name for nefarious purposes.
3. Saving/Investing
While these two often fall under the same heading, they are not quite the same. Saving is the act of putting money away for future needs. Investing is using money to make more money.
Either way, you should start with squirreling away enough cash to cover three to six months of living expenses. This will be very useful should you experience an interruption of your income. Having that “emergency fund” could also be the difference between managing a large unexpected expense with cash, rather than going into debt to do so.
With your emergency fund sufficiently endowed, your next endeavor should be the eradication of “bad” debt. Once that is accomplished, you can determine how much of your cash to hold aside for short-term needs and how much to invest to meet long-term goals such as retirement or paying for a child’s college education.
4. Insurance
Going through life without insurance is playing roulette with your lifestyle. Experiencing a serious car accident or a significant medical emergency as an uninsured individual could bankrupt you. Similarly, homeowners/renters insurance will help make you whole again in the event of a natural disaster, fire or burglary. These are just a few of the instances in which having insurance coverage can be of benefit.
The Bottom Line
Understanding and operating in accordance with these four main components of personal finance will stand you in good stead when it comes to setting and achieving your financial goals. They can also help you avoid uncomfortable situations in which you’ll have to choose between the lesser of two evils to survive.
