What is Personal Finance?
When trying to learn anything focusing on the fundamentals is the best way to see significant improvement and this is no different in the world of finance. With that in mind lets go back to basics and understand what is actually meant by the phrase ‘personal finance’. In basic terms personal finance is managing your money to achieve your financial goals. Taking a closer look however and this term can be broken into five separate areas which all play a role in you being better off financially and mastering how you utilise your money.
The Five Pillars of Personal Finance:
Income
This one is self explanatory, its difficult to plan for financial goals if you don’t have any income. For personal finance the first step is to be aware of what your income is. This isn’t just your main job but also any side hustles, and any passive income from investments or rental property. If its coming into your bank account on a regular basis its needs to be counted. The more accurate a figure you can get whether this is annually, monthly or weekly the easier the next steps and decisions will be. This is also the first pillar you should focus on improving as putting your time and effort into increasing your salary will provide a greater payoff than scrimping and saving continuously.
Spending
Looking into your outgoings is probably the first thing that comes to mind when you hear the term personal finance. For you to be able to set and achieve your goals you need to understand where your money currently goes and your spending habits. With mobile banking being so popular nowadays all it takes is a few taps and you can view all your transactions from the past months and years. If you don’t keep a track of your spending the first time you sit down and understand where your money is actually going each month can be quite eye opening. This initial understanding can help you make decisions around whether you are living within your means, areas where you could potentially cut back on and where you may want to redirect those funds. This is the basis of creating a budget, something I’ll be delving into in future articles. Now that we’ve gone over the literal ins and outs of your finances lets look at a couple options for how we utilise the remaining money.
Saving
Savings is the first vehicle we can use to achieve our financial goals. Simply put you siphon off some of your funds every payday into a savings account until you get to your target amount. You could do this for every financial goal but there are somethings which are better suited to saving than others. A general rule is any target set with a timeframe of below 5 years should be utilising the savings method. This is because you need to be sure you’re savings won’t have depreciated and the nominal value will remain at that target date. Things like a wedding, a new car and even a house deposit can all fit into this category as long as you know you need the money within the next five years or you cannot risk it going down at all.
Investing
Now you maybe wondering where you might park your cash if your goals have a longer time horizon say 10, 20 maybe even 30 years? Well investing is the answer. Investing allows the user to utilise the power of compounding and time to return sums which just aren’t physically possible with the low interest rates seen in savings accounts.
You can invest in many different things such as property, commodities, bonds and the most well known stocks and shares. These are known as different asset classes. Assets have volatility meaning their worth can go up as well as down. This is why you don’t want to invest all your hard earned savings only to find yourself worse off 2 years later and you cant afford the holiday of your dreams anymore. After 5 years however the probability of you being worse off are reduced and keep on reducing the longer you stay invested. This of course only applies when your investment portfolio is well diversified with assets at the correct level of risk for you.
One of the key areas where you may already invest without you even realising it is your pension. Here in the UK you are now auto enrolled into a workplace pension. The pension provider will then automatically put your money into a ‘default fund’. This is a selection of assets usually split between equity (stocks and shares) and bonds. Investing is the perfect vehicle for retirement savings due to their naturally long time horizons and monthly contribution system allowing users to reap the rewards from compounding.
Protection
This is the final pillar of personal finance and the most overlooked. Protection includes all the insurances you have and other countermeasures that will allow you to still be financially secure even if the worse was to happen. The first safety net we can implement is an emergency fund. This is a pot of savings which should only be touched if/when an emergency arises. This could be losing your job, your boiler suddenly dying or a repair for your car. By having a pot ready for just these occasions you’ll immediately feel more in control of your finances and feel happier about putting money away long term as you wont have to remove it if things go wrong. It is recommended this pot size should be 3-6 months of your living expenses.
Other security measures you can put in place are in the form of insurance. Some examples are health insurance and life insurance. Having these in place can provide peace of mind and financial security with you knowing that you’ll be covered if the worst were to happen and your loved ones will have less to worry about. Tax efficiency can also come under this bracket as being tax efficient means your money is working harder for you and not the tax man.
In Conclusion
These five pillars create the umbrella term which is personal finance and is the perfect introduction as to what I will be discussing on this website. I will be discussing all these five areas in detail so that you can learn and decide for yourself what’s best for your finances. By mastering these five areas you’ll be the owner of a robust plan for your finances allowing you to work towards any financials goals you might have. If there’s anything specific you’d like discussing feel free to comment below. Happy investing everyone!
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
