A basic understanding of financial concepts and personal finance is essential to manage your money well. Whether you are paying your bills or doing your taxes or saving for a home, financial literacy will help you make better decisions at every step of your financial journey.
Money management is an important skill that will benefit you throughout your life so it is important that you understand the basics of personal finance and gradually build your knowledge from there.
In this chapter, we will aim to understand the basics of personal finance along with its different elements and know some of the principles of personal finance.
What is Personal Finance?
Personal finance is the process of planning, organizing and managing money in one’s life. Personal finance includes savings, budgeting, investing, credit management, insurance, retirement and tax planning.
The primary aim of personal finance is to help you reach your financial goals, both short-term (buying a car, or a gadget) and long-term (planning for retirement). All your financial goals depend on your income, expenses, future desires and dreams and planning your personal finance will help you to fulfill all your financial goals.
And to make good financial decisions, you must be financially literate and know the pros and cons of all the available financial options.
Elements of Personal Finance
The main elements of personal finance are:
- Income - It is the money that you receive for work or through investments, on a regular basis. The common sources of income are salary, bonuses, pension, dividends etc.
- Spending - This includes all the expenses that you incur on buying goods and services that are consumable. You can pay for your expenses either through cash or credit. Most of your expenses can be incurred on rent, taxes, food, entertainment, travel, credit card payments etc.
- Saving - It is the money left after you have taken care of your basic necessities. This surplus amount left after deducting your expenses from your income can be directed towards a savings account or considered for investments.
- Investing - This is the process of putting money into various financial instruments such as stocks, bonds, mutual funds, real estate expecting a higher return than the original amount. While some investments are more risky than others, the rate of return also varies between them. It is always advisable to do proper research before investing your money in any financial instrument.
- Protection - It is the process of building financial resilience against any unforeseen circumstance. Financial instruments such as emergency funds, insurance can protect you in adverse situations. It is important to build protection while managing your personal finances.
Principles of Personal Finance
Staying on track with your finances requires a good understanding of the basic principles of personal finance: Prioritization, Assessment and Restraint.
Prioritization refers to the review of your finances to ensure a steady flow of income and stay focussed on continuing and growing your income.
Assessment is the skill to assess your financial health and knowing the costs and benefits of any financial activity. Whether it is about buying a house or making an investment, you must be able to review the pros and cons of the situation and make a decision accordingly.
Restraint is the ability to learn to restrain from non-essential spending and focus on building savings and practising good financial habits. Spending more than you earn can be a major sign that you need to practise restraint.
These three principles are crucial in building your financial health and net worth in the long run.
