What is Personal Finance?

Personal Finance Defined

Personal finance is the evaluation and management of a household’s economic activities. As a discipline, it concentrates on budgeting, saving, investing, insuring, and transferring. As a practice, it specializes in advising individuals and families on the achievement of their financial goals. Hence, the primary component in personal finance is financial planning. In essence, this is an interactive process that examines a person’s monetary goals and develops strategies to achieve them. Thus, creating a financial plan is one of the most important steps in attaining economic success.

Personal Finance Discipline

Personal finance is a discipline within the financial services industry. As shown below, this specialty concentrates on five main areas: budgeting, saving, investing, insuring, and transferring.

01. Budgeting

Budgeting is the systematic planning of estimated expenditures during a certain period. Specifically, a budget is a plan which aligns future income and expenses. For example, common sources of income include wages, salaries, bonuses, pensions, and dividends. By contrast, common sources of spending are food, housing, taxes, and entertainment. On balance, income should equal or exceed expenditures. However, an individual’s budget often depends on age, lifestyle, and preferences. Nevertheless, efficient budgeting is crucial to prudent personal financial management.

02. Saving

Saving involves forgoing immediate spending on consumption to increase future income through dividends, interest, and capital appreciation. When there is a surplus between what one earns and what one spends, an individual can direct the excess towards savings or investments. Prevalent forms of saving include physical cash, checking accounts, savings accounts, and money market instruments. Ultimately, saving is essential to financial success.

03. Investing

Investing is the act of dedicating assets to the generation of income or profits. There is a wide spectrum of assets in which individuals can invest and earn an income. Some of the more popular categories of investing include stocks, bonds, funds, investment trusts, and commodities.

Among the various asset classes, risk and return expectations vary widely. Yet, there is a fairly direct relationship between risk and return. Thus, low-risk investments generally yield lower expected returns, while high-risk investments produce higher expected returns. Even so, standard guidance suggests that individuals should invest in a variety of assets because diversification lowers overall risk.

04. Insuring

Insuring concerns protecting against financial risks, like theft, damage, injury, or death. Specifically, an owner pays premiums to an intermediary in exchange for guaranteed proceeds to a beneficiary in the event of loss. Typical insuring products include life, health, homeowner, and auto policies. Characteristically, this is a complicated area of personal finance. Therefore, people usually seek professional advice for ways to protect against unforeseen and adverse financial events.

05. Transferring

Transferring is the change of ownership from one party to another. Usually, when a person decides to transfer their assets, they will use estate planning. Essentially, this is a process that helps individuals direct who will own and manage their assets after their death or incapacitation. The most common types of estate planning tools are wills, trusts, beneficiary designations, powers of appointment, and powers of attorney. All in all, estate planning is a quick, tax efficient way to transfer assets to heirs.

Personal Finance Practice

Personal finance is a practice that advises households on the achievement of their financial goals. From debt reduction to retirement funding, individuals and families have a wide range of financial objectives they wish to attain. Thus, a solid investment plan can help keep investors and advisors on track.

Personal Finance Process

The key component in personal finance is financial planning. Basically, this is a process that defines one’s economic goals and develops strategies to achieve them. As per the Certified Financial Planner™ Board, the financial planning process involves seven steps:

Personal Finance Importance

Personal finance is becoming increasingly more important to people’s everyday lives. For instance, it is becoming essential for the average family to know how to budget its expenses and save for college costs. Also, they need to know how to invest their retirement portfolios, insure their lives, and transfer their wealth. Accordingly, to achieve these goals, individuals and families need to plan. Financial planning can help investors better control their personal finances.