Personal finance refers to how you manage your money, including your income, expenses and savings. When you put an effort into managing your personal finances, you have a better grasp on where your money is going and what changes you can make to meet your future financial goals.
Areas of Personal Finance
In this article, we are going to focus on breaking down the most important areas of personal finance and explore each of them in more detail so you have a comprehensive understanding of the topic.
As is, the main areas of personal finance are income, spending, saving, investing, and protection. Each of these areas will be examined in more detail below.
Income refers to a source of cash inflow that an individual receives and then uses to support themselves and their family. It is the starting point for our financial planning process.
Common sources of income are:
- Commission Income
- Business/Professional Income
These sources of income all generate cash that an individual can use to either spend, save, or invest. In this sense, income can be thought of as the first step in our personal finance roadmap.
Spending includes all types of expenses an individual incurs related to buying goods and services or anything that is consumable (i.e., not an investment).
All spending falls into two categories: cash (paid for with cash on hand) and credit (paid for by borrowing money). The majority of most people’s income is allocated to spending.
Common sources of spending are:
- Mortgage payments
- Credit card payments
- Studies/ Student Loan
The expenses listed above all reduce the amount of cash an individual has available for saving and investing. If expenses are greater than income, the individual has a deficit. Managing expenses is just as important as generating income, and typically people have more control over their discretionary expenses than their income. Good spending habits are critical for good personal finance management.
Saving refers to excess cash that is retained for future investing or spending. If there is a surplus between what a person earns as income and what they spend, the difference can be directed towards savings or investments. Managing savings is a critical area of personal finance.
Common forms of savings include:
- Physical cash
- Savings bank account
- Current bank account
- Money market securities
- Provident fund
- Fixed Deposits
- Government securities
- Real Estate(Wealth)
Most people keep at least some savings to manage their cash flow and the short-term difference between their income and expenses. Having too much savings, however, can actually be viewed as a bad thing since it earns little to no return compared to investments.
Investing relates to the purchase of assets that are expected to generate a rate of return, with the hope that over time the individual will receive back more money than they originally invested. Investing carries risk, and not all assets actually end up producing a positive rate of return. This is where we see the relationship between risk and return.
Common forms of investing include:
- Mutual funds
- Real estate
- Private companies
Investing is the most complicated area of personal finance and is one of the areas where people get the most professional advice. There are vast differences in risk and rewards between different investments, and most people seek help with this area of their financial plan.
Personal protection refers to a wide range of products that can be used to guard against an unforeseen and adverse event.
Common protection products include:
- Life insurance
- Health insurance
- Estate planning
This is another area of personal finance where people typically seek professional advice and which can become quite completed. There is a whole series of analysis that needs to be done to properly assess an individual’s insurance and estate planning needs.
The Personal Finance Planning Process
Good financial management comes down to having a solid plan and sticking to it. All of the above areas of personal finance can be wrapped into a budget or a formal financial plan.
These plans are commonly prepared by personal bankers and investment advisors who work with their clients to understand their needs and goals and develop an appropriate course of action.
Generally speaking, the main components of the financial planning process are:
- Plan development
- Monitoring and reassessment