The Basics of Personal Finance: A Beginner’s Guide
Growing up, I had a vague idea of what personal finance was, which can be characterized as a responsibility or chore for all adults. I had a vague understanding of the difference between income and expenses. I knew to save for retirement. I knew that I should pay my credit card balance in full each month. However, I never really took the time to understand the potential possibilities personal finance unlocks for oneself and that the key to building wealth is in your own hands.
What is personal finance?
I wanted to develop a definition of personal finance that allows me to communicate the core components and benefits of having a holistic knowledge of personal finance. After speaking with several people who were interested in being able to communicate a clear definition of personal finance to other individuals, I came up with five core components that comprise personal finance. How Much Do You Need to Start? Regardless of your age, we all have to start somewhere. Without income, there is no money for the types of education that lead to personal financial stability. This money is often referred to as an emergency fund, and it represents your “safe” money that can be accessed during an unplanned hardship, such as a loss of employment, an unexpected illness, or a car accident.
The big picture
I feel an overwhelming sense of dread, both deep and uncomfortable, when I think about how much money I’m going to have when I retire. As a working professional, balancing the interim and planning for decades into the future is something I’ve had to deal with for as long as I can remember, and it can be dreadful at times. But when it comes down to the core, you’re in charge of your own financial future, as well as the well being of your family. Once you understand what personal finance is, you can decide the best way to prepare for it. Personal finance does not have to be this mysterious and scary thought for you to really get into it and learn. Here are some areas you can start on: Budgeting. Every paycheck, keep a detailed record of your expenses and income. Be prepared to audit your recurring expenses. I use a prioritization technique from my product management days called the MoSCoW technique to determine needs vs. should haves vs. will nots. Finally, Look for ways to get your money to start work for you through various types of investing such as real estate, stocks, crypto, etc.
The basics of personal finance
Personal finance can be broken down into a few simple categories, the first being the general concept of “saving” in which you invest in a method of acquiring financial stability in the form of a lump sum or regular contributions. General Save 20 to 30 percent of your income, to a maximum of 10 percent. These funds are used to help pay for your retirement, paying off credit cards, investing in a 401K, or other standard savings accounts. This is the baseline goal for most people. To diversify your investments, find accounts with low fees, moderate annual returns, and reasonable liquidity, and also look for higher investment yields and broader portfolio exposure. The next category is “owning” the fruits of your labor.
In his book, “Rich Dad Poor Dad,” Robert Kiyosaki describes wealth in four categories: income, assets, obligations and wealth. Kiyosaki defines assets as all the things that we earn or receive from others, including our job, our house, the cars we drive, the clothes we wear and the food we eat. Assets make up 70 percent of our net worth. With a high rate of savings, we are in a position to own assets which in turn can make us wealthy. An example of an asset would be a rental property. Therefore, if someone owns multiple rental properties, they are likely to have a fairly large net worth because these assets produce income for the owner which can be used to purchase more assets or to pay for the bills and other living expenses of the owner like their own home mortgage, car payment, etc.
In general, understanding personal finance starts with a few simple steps, which can be summarized as follows: Know your goals. By understanding your priorities, you can begin to see what items you would be willing to live without to reach your goals. Know your numbers. This may be as simple as knowing how much you earn. This may also be the reason why you need an emergency fund, or why you need to save more money for retirement. However, the more critical step is to understand your cash flow. Develop a budget. A budget will allow you to identify what you spend each month on various categories. The goal of a budget is to develop a spending plan that will help you make more conscious decisions about how you spend your money. Once you have a lucid understanding of your cash flow and budget you can begin to take steps to acquire assets to begin building wealth.