Personal Finance explained for beginners part 1 – that will be the topic of today’s article.
Personal Finance is one of the most important aspects of everyone’s life, which is often not taken seriously by most people in the world.
According to our opinion, handling your finances should be thought about from an early age, just like many other essential things that are to be learnt.
For example, children should be taught personal finance, traffic education, swimming, driving, moral values, and so on, and by doing so, the future generation will have the knowledge they require to do some important stuff.
In most schools, nowadays, children are being taught some basic education related to personal finance, which will prove out to be helpful for them in the future.
However, this might be the case in all countries, and to help the people, we are here to provide some fundamentals regarding personal finance that everyone should know.
Most people often have some misconceptions related to personal finance, and in such circumstances, people don’t want to show enthusiasm in learning about it.
In layman’s terms, Personal Finance simply refers to the process of handling your money and being able to save and invest the money you have earned.
This includes various types of money-related features such as budgeting, mortgages, loan repayment, banking, investing, tax planning, estate planning, etc.
This specific word describes the industry as a whole, which offers financial services to individuals, families, or other entities. Alternatively, the industry can also mean offering financial advice or advice related to investment opportunities.
Why is it necessary?
The most important personal financial objectives are to achieve your money-related goals and maintain financial stability.
Regardless of whether it is for short-term goals such as buying things you need, or for long term goals like retirement planning, it is necessary for you to have a good knowledge of all the terminology related to personal finance.
Personal financial goals rely on some influential factors like your age, your income, financial motives, cost of living, etc.
When you have a robust personal financial plan, it would be easy for you to achieve what you want in life (financially).
Moreover, if you already acquire financial services from a professional, having good financial literacy allows you to make the right financial suggestions, with no respect to what the professional has to say.
Finally, as humans, we are designed to evolve, and we don’t mean it scientifically, but instead, we mean it financially.
Imagine being born in a poor or middle-class family and struggling through life to become rich. With the right amount of financial literacy, financial discipline, and a sound financial strategy, the process becomes far easier.
Remember, a goal without a plan is just a dream, and also, doing something for 20 minutes is far better than thinking about it for 20 minutes.
To make all the process very simple for you to understand, we’ve divided the whole topic of personal finance into five different areas, which are as follows:
Having said that, let us start by discussing income and all things related to it.
Any sort of cash inflow that is received by a person or a family is commonly referred to as “Income”. Usually, this cash flow is necessary for individuals to support themselves or their families.
In reality, income is the key factor for managing personal finance as it would be nigh impossible to handle your finances without it. Income can be called with various types of names depending on how it is obtained.
Salary – The most common form of income is through salaries, where the employers pay individuals (employees) in return for the services acquired by those employers from the individuals.
Wages – Then there are wages, which are nothing but salaries, but are paid based on hours worked. These wages, put together for a specific period, can also be called a salary.
Bonus – when the employer is extremely satisfied with your work and wants to do something more than just paying your salary, then the employer offers bonuses.
Nothing but the amount of money paid additional to the salary, and usually paid during holidays.
Pension – Pension is paid to the people who are of retirement age and is generally paid by the government.
Individuals have to contribute money towards pension schemes while they are employed and should meet the criteria related to pensions.
For example, people in some countries qualify for pensions after a few years of service and by reaching the retirement age limit. In some other countries, there would be restrictions like in the UK, where the individual has to pay National Insurance contributions for 30 years.
Interest – This is something that you earn for putting your money somewhere like a bank, and the interest rates vary on certain factors like the amount you’ve put in, the term for the deposit, and the borrower (bank).
Apart from these, there are some other types of income like commissions, dividends, profits from sales, profits from investments, pocket money, etc., which are also considered as income by definition.
First, you have to derive income one way or another, so that you can save it, budget it, invest it, or spend it.
As we completed talking about income, now we shall move on to our next topic in our list of personal finance, i.e., expenditure.
Expenditure covers all types of expenses of an individual, regardless of their purpose, and by keeping your expenses limited, you can save more money.
Expenses can either be made with cash or credit and are correlated with the income, so as to how you manage your finances.
In general expenses of an individual are rent, utilities, loan payments, entertainment, etc.
Most of these expenses are necessary for a person to survive, and therefore, expenses consume a significant portion of your income.
As we are talking about expenses, you should always understand the importance of frugal living and buy only the things you need rather than the things you want.
You should always remember that taking care of your family and planning for your retirement would always be beneficial compared to buying sports cars or flexing your assets.
Buying assets is a good thing because it creates some ambition among us, however, this might also lead to an obsession for a lavish lifestyle.
Now let’s talk about savings, which refer to the funds that have been saved by an individual for future purposes. When the expenses are lower than the income, then you can put your money into savings or investments.
Savings are the funds that a person wishes to save for emergency spending, achieving short term goals, long term goals, etc.
For example, saving money as an emergency fund would come in handy under unexpected circumstances such as job loss.
You can save money with the help of various types of financial instruments such as savings accounts, deposit accounts, money-market assets, etc.
In other ways, you can just save money physically in the form of cash or buy some rare commodities such as gold or store it in bitcoins.
Note: You should remember that when money has been kept idle, you will lose the opportunity of gaining more money over the money you’ve earned.
Furthermore, you cannot rely on highly volatile assets such as cryptocurrencies because nobody can predict the price of such assets. Therefore, you should have a balanced portfolio, which should be carefully monitored and rebalanced every now and then.
Savings also come in handy for people when they are not able to maintain the cash flow between income and spending.
Nevertheless, financial instruments related to savings always offer very little returns or no returns at all, and this would be a wise thing to do. Only a fraction of the money should be kept in savings because too much of anything can be bad for you.
Some of the general terms that are related to “savings” are as follows:
Investing is a process where you put in your money to earn some profits on that money over a particular period. In this way, the person would receive more than what they’ve put in with the help of investing.
Some factors affect investments such as risk, rate of return, and else, and you should also remember that there is no guarantee that you might always receive profits (there may be losses).
There are various types of investments that we can’t discuss in a single article. However, we have provided various articles that describe various types of investments such as stocks, bonds, investment funds, real estate, etc
just to provide you with a general insight into how they work, we’ll briefly discuss some of the mainstream investments such as stocks, bonds, and others.
Stocks – stocks (collections of shares) are nothing but the fractions of ownership that represent a company or any other entity that is formed legally.
To know more details about stocks, then click here.
Bonds – A bond is a debt instrument, where you will be acting as a lender while agreeing to lend money to a government or a company.
The issuer of the bond would usually guarantee that they would repay the total amount in the future which would be referred to as the maturity date.
Before they pay the total amount, they would keep on paying the lender an interest rate which is called a coupon rate.
In most cases, bonds are issued by governments to fund their activities such as paying their employees or carrying out developmental activities.
Bonds are considered to be safe when compared to most other types of investment opportunities and by being safe they usually return profits that are relatively rare compared to most other investments.
Investment Funds – There are various types of investment funds such as mutual funds, ETFs, hedge funds, index funds, trust funds, etc. most of these funds are handled by fund managers who pool the money of investors and invest it in various types of assets.
we’ve done 3 articles on investment funds while explaining various types of investment funds and how they work. you can access all the information regarding different types of investment funds by clicking on the links given below.
Real Estate – Similar to investment funds, there are various types of investment opportunities that lie within the realm of real estate. some of the major types of real estate investments are flipping, renting, Real Estate Investment Trusts (REITs), service documentation, etc.
for the past few decades, investments that have been made in assets such as precious metals or real estate have allowed investors to reap benefits compared to what they gained when they have invested in other types of assets.
However, there’s no denying the fact that even the real estate market is susceptible to losses and the housing bubble of 2008 is a perfect example of it.
To know more details about different types of real estate investments and how they work click here.
When talking about personal finance, when we say protection we refer to the various types of financial products that allow an individual to access safety in an unexpected event.
Some examples of the types of protection-related financial products that can help you in unexpected circumstances are life insurance, health insurance, estate planning, etc.
Just like every other aspect we discussed earlier, protection also plays a key role while you are handling your financial situation.
After having discussed the core aspects, we will now take a look at other aspects that are considered important in terms of personal finance.
Budgeting refers to a process where you effectively handle your spending. That’s right! you plan for your spending with a single strategy that effectively helps you save more money.
Having a plan beforehand allows you to maintain efficiency while spending money and knowing what you can get with the money you have.
You don’t even necessarily need to have a strategy where you save every month because the main ideology is to maintain a balance between your income and expenditure.
In any sort of plan that you make for a budget, there are five crucial steps which are given below.
First of all, you must determine your income, and this should include the income from all your sources. Even if you are not sure about how much you exactly earn, having an estimated amount would be helpful.
In the next step, you have to determine all your expenses. This could either be done through a rough estimate or by tracking your expenses for a couple of months.
You don’t manually have to monitor all your expenses as there are various types of smartphone applications that allow you to track your spending activity.
Now, the following step is to create a failproof budget plan after determining the income and expenses. To help you choose a budget plan that suits your needs, we’ve come up with some interesting strategies.
Zero Budget – The main objective of a zero budget is to allocate every single dollar you earn into different categories such as debt repayment, spending, savings, investment, etc.
The main objective of a zero-budget plan is to have no balance amount at the end.
50/30/20 Strategy – You might already be familiar with the 50/30/20 strategy, and if you are not, don’t worry because we will explain it.
You will start by allocating 50% of your income to your expenses (needs), and then, you will allocate 30% for personal purposes (wants), and finally, you will allocate 20% to savings or investment or debt repayment.
You can allocate the 50/30/20 plan according to your own financial goals.
Envelope System – Even though this is an old school method, people have found this budgeting strategy to be quite effective. For this method, you should opt for using cash instead of digital money.
As the name itself suggests, you use envelopes to allocate money for different types of needs. For instance, you can use an envelope of expenses, an envelope for debt repayment, an envelope for investments, etc.
This allows you to have some financial discipline as you cannot use any extra money other than what has been allocated to each envelope.
Applications – There are various types of mobile applications that are available nowadays, which allow you to take care of the budgeting process easier.
Some of the best budgeting apps available for people are given below:
- You Need A Budget (YNAB)
- Personal Capital
After selecting a budget method, now what you need to do is to adjust your habits. Why is it necessary? After following the methods told by us, or any other budget method, you will get an exact idea of your expenses.
You might be paying a lot for the car that you cannot afford, or you might be binge shopping for the things that you don’t need.
Through this estimate, cut out the expenses that aren’t important for you, and try if you can acquire goods and services for a lower cost than what you are spending.
Make some amends to your budget plan by allocating how much you spend and how much you can save by lowering your expenses.
A budget plan isn’t necessarily some sort of plan that is mandatory for you to follow. Instead, it can be changed regularly based on your needs, requirements, and goals.
We get it that all this process can be burdensome, but it will be worthy of all the effort when you are trying to manage your finances. With the help of a budget plan, you can seamlessly take care of your expenses, plan for emergencies, save for your goals, etc.
Budget can be a great financial tool there is for managing your financial situation efficiently.
Some important terms related to personal finance:
Given below are some of the terms that most people usually hear every day, especially when they are taking care of their financial situation.
Most people usually get confused between the terms debt and a loan, but you should understand that there are some slight differences between the 2 terms.
When it comes to debt, it means that something is owed to an individual from another. this can refer to money, property, assets, services, or any other similar thing.
While talking about investments, that usually refers to the money that has been raised with the help of debt instruments such as bonds.
On the other hand, a loan is a form of debt that particularly represents an agreement between the party that is lending the money and the party that is borrowing it.
Here, the party who is lending the money usually comes up with the terms and conditions related to repayment such as how much should be paid and when it should be paid.
The lender is also responsible for setting the amount of interest that is to be paid along with the loan.
When it comes to debt instruments, they are nothing but the financial tools that have been issued by governments, individuals, businesses, or other entities to obtain capital.
Debt instruments work in such a way that the entity that is borrowing the money will ensure the lender that the capital obtained would be repaid over time while offering some benefits to the lender.
Various types of financial instruments such as credit lines, bonds, credit cards, loans, etc., are considered to be good examples of debt instruments.
- Credit score
A credit score is a number that usually ranges between 300 to 850 and this number represents the creditworthiness of an individual.
As a general rule of thumb, people with a higher credit score are most likely to acquire a loan when compared to people who have a low credit score.
Nowadays, most lenders are considering credit score as an influential factor before they offer a loan to an individual.
The credit score of a person is usually affected by various factors such as the number of loan accounts that are still open, the repayment history of the individual, timely payments, etc.
In layman’s terms, people with higher credit scores look somewhat creditworthy to the lenders as they have good repayment history and the ability to clear the loan without default.
Most financial institutions opt for the FICO scoring system when it comes to considering the credit score of an individual.
This scoring system or credit score model was created by the Fair Isaac Corporation, which in short is called FICO, and gained a lot of popularity even when there are some other types of scoring systems.
To make it simple for you to understand, a person’s financial situation is exactly represented by their credit score these days.
It becomes hard for people to acquire loans or mortgages when they have a credit score that is lower than 640 and adding to that, they would even have to pay higher interest rates even if they acquire one.
People with a higher credit score like as much as 780 or 800 r usually preferred by lenders and even get loans at discounted interest rates.
In general, a credit score that is 700 or higher is considered as an optimum credit score in the eyes of a lender, whereas, a credit score higher than 800 would be considered as an excellent credit score.
Anything below 570 would be considered as a poor credit score and it becomes extremely hard for an individual with such a credit score to acquire a loan or a mortgage.
How exactly is it calculated? – So, there are 3 major credit reporting agencies in the United States namely Experian, Equifax, and TransUnion,
These 3 credit reporting agencies are responsible for reporting, updating, and securely storing the credit histories of the consumers living in the United States.
Even though there can be differences in the information that has been gathered by these 3 credit reporting agencies, all the credit scores are influenced by 5 major factors which have been provided below.
- payment history
- total amount/debt owed
- length of credit history
- type of credit
- new credit or recent credit
So here’s the process on how the credit score of an individual is calculated depending on these 5 factors.
Up to 35% of the credit score of an individual is influenced by the payment history of that specific individual. another 30% is influenced by the total amount owed by that person.
The total amount owed is calculated based on the percentage of the credit that is available for the person and the percentage of credit that is currently being used by that person (credit utilization).
The length of credit history accounts for 15% of the credit score, and long credit histories would be determined as less risky because there is an availability of more data to determine the payment history.
The type/types of credit account for 10% and represent the person’s instalment credit and revolving credit.
Instalment credit refers to loans where the debt repayment he’s done with the help of instalments and one good example for instalment credit is a mortgage.
Revolving credit is where the credit would be replenished after the debt has been cleared and a perfect example would be a credit card.
New credit or recent credit he’s responsible for 10% of the credit score, where the number of new accounts the person has and the number of new accounts the person has applied for are usually taken into consideration.
How to improve your credit score – Yes, it is possible for anybody, even people with a low credit score, to improve their credit score by following the tips that have been given below.
- First of all, make sure that you pay your bills on time. Even when you’re paying your bills on time for a period as low as 6 months, there would be a significant change in your credit score.
- Now, increase your credit line. if you already have credit card accounts, then call your credit card provider and ask if you can increase your credit.
If your payment history is good, then the provider would have no problem increasing your credit limit.
It should be taken into careful consideration that we should not spend this extra credit limit to maintain a lower credit utilization rate.
- Never close a credit card account. even when you are not using a credit card, it is wise if you stick to stopping using it rather than closing the account.
Based on factors such as your age in the credit limit of your credit card, your credit score might be affected if you close a credit card account.
For example, let us assume that you have $1000 debt and a $5000 credit limit that is split evenly between 2 cards. while you have the 2 accounts, the credit utilization would be around 20% and is considered good. However, when you choose to close an account, the credit utilization would increase to 40% and your credit score would be affected negatively.
- Opt for credit repair companies. Yes, there are some financial institutions, which are known as credit repair companies that would try and improve your credit score when you don’t have the time to do it by yourself.
These credit repair companies would go ahead and make some amendments with your creditors on your behalf. not just the creditors, but they would also try and negotiate with the credit reporting agencies so as to increase your credit score.
To do all this, most credit repair companies charge a monthly fee from their customers. even though they charge money, it is worth it because you can get a lot of benefits once your credit score improves.
Like the saying “prevention is better than cure”, you should always remember the fact that maintaining a healthy credit score from the beginning is better than repairing your credit score after it has been damaged or impacted negatively.
Having a good credit score would allow you to maintain good financial stability as you can get loans and debts at lower interest rates.
However, nobody could ever be certain of a person’s financial situation, and when things go South, the tips that have been provided above would come in handy for you to take care of your credit score scenario.
- Personal Net Worth
As for the general definition, net worth is nothing but the value of the entire assets owned by an individual or a corporation while deducting their liabilities.
It is a crucial metric to determine a person’s or a company’s financial health while providing a general insight into the financial scenario.
Not just for individuals or corporations, net worth is a concept that is even used to measure the value of sectors or even countries for that matter.
People who have a significant net worth are usually referred to as high net worth individuals, and the services required by these individuals are very a lot compared to the services required by regular individuals.
In personal finance, the liabilities of a person, which are also known as debt, are usually mortgages, credit card balances, or any other type of loans that they have acquired.
On the other hand, the individual’s assets refer to their account balances, the value of the securities they hold (such as stocks, bonds, etc), real estate properties, and other types of assets.
While considering the value of assets such as automobiles or antique art pieces, or any other similar belongings, the market value of the asset would be taken into consideration while determining the net worth.
This doesn’t just apply to the assets, but even the debt be considered as per the current market value at that time while determining the net worth.
Whatever the person would be left with after they’ve sold everything they have and paid off all the debt is known as that person’s net worth.
Negative net worth – yes, there is even a possibility for a negative net worth, where the total debt of a person is higher than all the assets they have.
For example, when an individual’s credit card bills, outstanding loan payments, student loans, etc., account for a value higher than the value of the assets they own, then their net worth would be considered negative.
Negative net worth is an indication that either the individual or the family would have to concentrate on the process of debt reduction as soon as possible.
For such people, handling the personal financial situation is very important including creating a tough budget, understanding the importance of frugal living, and perhaps even saving some money for clearing of some of the significant debts/loans.
It might become extremely hard for such people to become financially independent, however, with the right type of determination, hard work, focus, and financial habits, they could get out of the negative net worth scenario and even gain some financial stability.
Sometimes, situations get out of hand and there’s nothing we, as humans, can do anything, to get out of negative net worth. and in such circumstances, it would be an appropriate choice to file for bankruptcy protection.
This allows the individual or the family to get rid of some of the debt and stop the creditors from taking harsh measures on them. However, when you file for bankruptcy protection, your credit report would be affected for decades, and there’s nothing that you can do about that.
Therefore, maintaining a good financial situation is very important.
Taxes are the charges that are levied by governments or the local authorities on individuals or corporations, and the taxes can be local, regional, or national (mostly).
Usually, governments impose taxes so that they can take care of their activities such as development activities like roads, schools, paying employees, offering benefits to employees, offering benefits to citizens, and so on.
Taxes are the major source of revenue for any government to take care of their expenses.
There are various types of taxes that are usually imposed as a percentage of the income that has been obtained by an individual or a corporation.
For example, individuals are imposed with an income tax at different marginal rates on the income that has been obtained in the form of salary.
The type of tax, and whether it is imposed or not, would solely be dependent on the government, and for instance, some countries might have an income tax, whereas some countries don’t impose income tax on their individuals.
We have another part for this article that covers the remaining aspects of personal finance that we thought were important. Along with those aspects, we also provided some general definitions for various terms related to personal finance and investments.
Learning everything about personal finance might become hard for someone as they might already be occupied with their profession or any other passion.
In such circumstances, taking care of your personal financial situation becomes extremely hard and might even lead to financial difficulties.
If you are a high net worth individual and are having trouble finding the relevant financial services that suit your needs, then we got you covered because we offer the best in class financial solutions that are specifically tailored for high net worth individuals such as you.
To get access to our expert financial solutions, please click here.
You can even get access to over services with the help of our mobile application, and for that, click here and download our app.
Those who want to take care of the financial situation on their own can gain all the financial wisdom and the necessary knowledge by becoming a part of our Adam Fayed Academy.
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