What is ‘Personal Finance’
Personal finance is the science of handling money. It involves all financial decisions and activities of an individual or household – the practices of earning, saving, investing and spending.
Matters of personal finance include the purchasing of financial products, like credit cards, life, and home insurance, mortgages and investments.
Breaking Down ‘Personal Finance’
All individual financial activities fall under the purview of personal finance; personal financial planning generally involves analyzing your current financial position, predicting short-term and long-term needs and executing a plan to fulfill those need within individual financial constraints. It depends on one’s expenses, income, living requirements and individual goals and desires.
Among the most important aspects of personal finance are:
- Assessing expected cash flow
- Buying insurance
- Calculating and filing taxes
- Savings and investment
- Retirement planning
Personal Finance Planning Tips
Whether you’ve been in the workforce for years, or are a recent graduate just starting out, it’s never too late to create financial goals, security and freedom – both now, and for the future.
Here are the best practices and tips for personal finance.
1. Devise a Budget
Having a budget is the first mandatory step from which savvy money management will evolve. A budget is essentially a financial roadmap that allows you to live within your means, while having enough left over to save for long-term goals. The 50/30/20 budgeting method offers a great framework. It breaks down like this:
- 50% of your take-home pay or net income (after taxes, that is) goes towards living essentials, such as rent, utilities, groceries and transportation
- 30% is allocated to lifestyle expenses, such as dining out and shopping for clothes, etc.
- 20% goes towards the future: paying down debt and saving both for retirement and for emergencies
There are many options to choose from personal budgeting apps for smartphones that make managing and tracking your money easy. These apps can automatically update you on spendable cash as you make purchases each day or streamline cash flow, budgets, credit cards, bills and even investment tracking.
2. Create an Emergency Fund
It’s important to “pay yourself first” to ensure money is set aside for unexpected expenses–medical bills, rent if you get laid off, etc.
Between three to six months’ worth of living expenses is the ideal safety net. Financial experts generally recommend putting away 20% of each paycheck every month (which of course, you’ve already budgeted for!). Once you’ve filled up your “rainy day” fund (for emergencies or sudden unemployment), don’t stop. Continue funneling the monthly 20% towards other financial goals such as a retirement fund.
3. Limit Debt
This sounds simple enough – to avoid debt getting out of hand, don’t spend more than you earn. Of course, most people do have to borrow from time to time – and sometimes going into debt can be advantageous, if it leads to accumulating an asset. Taking out a mortgage to buy a house is one good example.
There can be other times when leasing is sometimes the better financial move to buying outright, be it in renting a place to live, leasing a car, or even getting a subscription to computer software.
4. Use Credit Cards Wisely
Credit cards get dinged for being major debt traps. But it’s unrealistic not to own any in the contemporary world, and they have uses other than as a tool to buy things. Not only are they crucial to establishing your credit rating, they are a great way to track spending – a big budgeting aid.
Credit just needs to be managed correctly, which means the balance should ideally be paid off every month, or at least be kept at a credit utilization rate minimum (that is, keep your account balances below 30% of your total available credit). Given the extraordinary rewards incentives on offer (such as cash back) these days, it makes sense to charge as many purchases as possible; still, avoid maxing out credit cards at all costs, and pay bills strictly on time. One of the fastest ways to ruin your credit score is to constantly pay bills late – or even worse, miss payments.
Using a debit card is another way to ensure you will not be paying for accumulated small purchases over an extended period – with interest.
5. Monitor Your Credit Score
Credit cards are the main vehicle through which your credit score is built and maintained, so watching credit spending goes hand in hand with monitoring your credit score. If you ever want to obtain a lease, mortgage or any other type of financing for that matter, you’ll need a solid credit history behind you. Factors that determine your score include: how long you’ve had credit, payment history and your credit-to-debt ratio.
Credit scores are calculated between 300 and 850. Here’s one rough way to look at it:
- 720 = good credit
- 650 = average credit
- 600 or less = poor
To pay bills, set up direct debiting where possible (so you never miss a payment) and subscribe to reporting agencies that provide regular credit score updates. By monitoring your report, you will be able to detect and address mistakes or fraudulent activity. Federal law allows you to obtain free credit reports from the three major credit bureaus: Equifax, Experian and TransUnion. Reports can be obtained directly from each agency.
6. Consider Your Family
To protect the assets in your estate and ensure that your wishes are followed when you die, be sure you make a will or trust. You also need to look into insurance: not just on your major possessions (auto, homeowners), but on your life. And be sure to periodically review your policy, to make sure it meets your family’s needs through life’s major milestones.
Other critical documents include a living will and healthcare power of attorney. While not all these documents directly affect you, all of them can save your next-of-kin considerable time and expense when you fall ill or become otherwise incapacitated.
And while they’re young, take the time to teach your children about the value of money and how to save, invest and spend wisely.
7. Pay Off Student Loans
There are myriad loan-repayment plans and payment reduction strategies available to graduates. If you’re stuck with a high-interest rate, paying off the principal faster can make sense. On the other hand, minimizing repayments (to interest only, for instance), can free up other income to invest elsewhere. Some federal and private loans are even eligible for a rate reduction if the borrower enrolls in auto pay. Flexible federal repayment programs worth checking out include:
- Graduated repayment – progressively increases the monthly payment over 10 years
- Extended repayment – stretches the loan out over a 25-year period
- Income-Based Repayment Plan – payments are calculated based on annual income and family size
- PSLF (Public Service Loan Forgiveness) – must make 120 qualifying payments under the standard, income-based, income-contingent, or Pay As You Earn repayment plan.
Finding the best loan-repayment program can be confusing and overwhelming since there are over sixty government programs available from the U.S. Department of Education. The advisers at Higher Level Processing are experts in finding the best program to suit your current financial situation to get loan forgiveness or at least a reduced student loan payment.
8. Plan (and Save) For Retirement
Retirement may seem like another lifetime away, but trust us: It arrives much faster than you’d expect. Experts suggest that most people will need about 80% of their current salary in retirement. The younger you start, the more you benefit from what advisors like to call the magic of compounding interest – how small amounts grow over time. Setting aside money now for your retirement not only allows it to grow over the long term, it can reduce your current income taxes, if funds are placed in a tax-advantaged plan fund like an Individual Retirement Account (IRA), a 401(k)or a 403(b). If your employer offers one of the latter two, you should start directing a portion of your paycheck towards it. Some companies will match your contribution – essentially free money. Start contributing pronto. Failing to do so can equate to tossing out tens of thousands of dollars along the way. Take time to learn the difference between a Roth and a traditional 401(k), if your company offers both.
Investing is only one part of planning for retirement. Other strategies include waiting as long as possible before opting to receive Social Security benefits (which is smart for most people) and converting a term life insurance policy to a permanent life one.
9. Maximize Tax Breaks
Due to an overly complex tax code, many individuals leave hundreds or even thousands of dollars sitting on the table every year. By becoming deliberate about maximizing your tax savings, you’ll free up money that can be invested in the reduction of past debts, your enjoyment of the present and your plans for the future.
You need to start each year saving receipts and tracking expenditures for all possible tax deductions and tax credits. Many business supply stores sell helpful “tax organizers” that have the main categories already pre-labeled. After you’re organized, you’ll then want to focus on taking advantage of every tax deduction and credit available, as well as deciding between the two when necessary. In short, a tax deduction reduces the amount of income you are taxed on, whereas a tax credit actually reduces the amount of tax you owe. This means that a $1,000 tax credit will save you much more than a $1,000 deduction.
10. Give Yourself A Break
Budgeting and planning can seem full of deprivations. Make sure you allow yourself some reasonable rewards now. Whether it’s a vacation, purchase, or an occasional night on the town, you need to enjoy the fruits of your labor. Doing so gives you a taste of the financial independence you’re working so hard for.
Last but not least, don’t forget to delegate when needed. Even though you might be competent enough to do your own taxes or manage a portfolio of individual stocks, it doesn’t mean you should. Setting up an account at a brokerage, spending a few hundred dollars on a certified public accountant (CPA) or a financial planner – at least once – might be a good way to jump-start your planning.
Personal Finance Strategies
Once you’ve established some fundamental procedures, you can start thinking about philosophy. The key to helping adults get their personal finances on the right track isn’t about teaching them a new set of skills. Rather, it’s teaching them that the principles that contribute to success in business and their careers work just as well in personal money management. Three key ones are: prioritizing, assessing and restraining.
Prioritizing means that you’re able to look at your finances, discern what keeps the money flowing in, and make sure you stay focused on those efforts.
Assessment is the key skill that keeps professionals from spreading themselves too thin. Ambitious individuals who always have a list of ideas about other ways they can hit it big, whether it is a side business or an investment idea. While there is absolutely a place and time for taking a flyer, running your finances like a business means stepping back and truly assessing the potential costs and benefits of any new venture.
Restraint is that final big-picture skill of successful business management that must be applied to personal finances. Time and time again, financial planners sit down with successful people who somehow still manage to spend more than they make. Earning $250,000 per year won’t do you much good if you spend $275,000 per year. Learning to restrain spending on non-wealth-building assets until after you’ve met your monthly savings or debt-reduction goals is crucial in building net worth.
Learning About Personal Finance
Few schools offer courses in managing your money, which means most of us have to get our personal finance education from our parents (if we’re lucky) or pick it up ourselves. Fortunately, you don’t have to spend much money to find out how to better manage it. You can learn everything you need to know for free online and in library books. Almost all media publications regularly dole out personal finance advice, too. If you enjoy the structure of lessons and quizzes, free digital personal finance courses are an option.
Above all, the most successful debt pay-off plans start with an actual plan. Figure out how much you can afford to pay each month toward the debt, then treat that lump sum amount like a fixed bill until all the debt is gone. Once you’ve paid it all off, you’ll already have a nice amount that you can direct toward saving for other goals.