What Personal Finance Is and Why You Need It

What is personal finance ?

Personal finance is about managing your money, saving, and investing. It includes things like budgeting, banking, insurance, mortgages, investments, retirement, taxes, and planning for your estate. It also covers the financial services that help individuals and families make smart financial decisions.

Your personal goals and a plan to reach them, while staying within your budget, affect how you manage your finances. To make the best use of your money, it’s important to learn about personal finance. This helps you make better choices and avoid bad financial advice.

Key Takeaways

Many schools don’t teach money management, so it’s important to learn through free resources like articles, courses, blogs, podcasts, or books.
The main areas of personal finance are earning money, spending wisely, saving, investing, and protecting your finances.
Smart money management means making plans for things like budgeting, saving for emergencies, paying off debt, using credit cards carefully, and planning for retirement.
It’s important to be disciplined with your money, but also know when it’s okay to be flexible with the rules.

The Importance of Personal Finance

Personal finance is about achieving your financial goals, whether it’s saving for short-term needs, planning for retirement, or funding your child’s education. It all depends on how you manage your income, spending, saving, investing, and protecting yourself with insurance and estate planning.

Not understanding money management has led many people into large amounts of debt. In August 2024, the Federal Reserve Bank reported that household debt increased by $3.7 trillion since 2019. Here are some key numbers from 2024:

Credit card debt: Increased by $27 billion
Auto loans: Increased by $10 billion
Consumer loans and store cards: Increased by $1 billion
Mortgages: Increased by $77 billion
Total non-housing debt: Increased by $28 billion
Student loans: Stayed at $1.6 trillio

As more people borrow to make purchases, managing personal finance becomes even more important, especially with rising prices and inflation reducing purchasing power.

Areas of Personal Finance

As more people borrow to make purchases, managing personal finance becomes even more important, especially with rising prices and inflation reducing purchasing power.

Personal finance can be broken down into five main areas: income, saving, spending, investing, and protection.

Income

Income is the money you earn, like your salary, wages, or dividends. It’s the money you have to spend, save, or invest.

Spending

Spending is the money you use to pay for things like rent, groceries, hobbies, eating out, and entertainment. Managing your spending is important—if you spend more than you earn, you might go into debt, which can be costly, especially with high-interest rates.

Saving

Saving is the money you set aside after spending. It’s important to save for emergencies or big expenses. Ideally, you should save enough to cover three to 12 months of living costs. But don’t let your savings sit idle in a bank account—invest it to keep it growing and protect it from inflation.

Investing

Investing means putting your money into things like stocks or bonds to earn more money. While investing can grow your wealth, it also involves risks because not all investments will increase in value.

Protection

Protection means safeguarding yourself from unexpected events like accidents or illnesses. It includes life and health insurance, and planning for your estate and retirement to secure your future.

Personal Finance Services

There are many financial services that help people plan and manage their money. These services cover different areas of personal finance, and businesses offer them to help clients stay on track with their finances. Some common services include:

Wealth Management: Helping you grow and manage your wealth.
Loans and Debt: Guidance on borrowing money and managing debt.
Budgeting: Helping you plan how to spend and save your money.
Retirement: Planning for your financial needs after you stop working.
Taxes: Advice on how to handle and reduce your taxes.
Risk Management: Protecting yourself against financial risks, like accidents or losses.
Estate Planning: Planning how to pass on your wealth to family or loved ones.
Investments: Helping you grow your money through stocks, bonds, etc.
Insurance: Protecting yourself from financial loss with policies like health or life insurance.
Credit Cards: Managing your credit and using cards wisely.
Home and Mortgage: Help with buying a home or managing your mortgage.

Personal Finance Strategies

Starting financial planning early is essential, but it’s never too late to set financial goals for yourself and your family. These goals can help you secure your financial future and achieve the freedom to make choices in life. Here are some best practices and tips for managing your personal finances.

A 2022 survey by Investopedia found that many people are worried about managing personal finances, saving for retirement, and understanding investments in areas like cryptocurrency.

1. Know Your Income

Before making any decisions about budgeting or saving, it’s important to know exactly how much you take home after taxes and deductions. This number is crucial to understanding your financial situation and making informed decisions.

2. Create a Budget

A budget helps you live within your means and save enough money to reach your long-term financial goals. One popular method for budgeting is the 50/30/20 rule. Here’s how it works:

50% of your take-home pay goes to essential expenses like rent, utilities, groceries, and transportation.
30% is for non-essential spending, like eating out, shopping, and other personal expenses. You can also use this portion for charity donations.
20% should go towards future goals, such as paying down debt, saving for emergencies, or putting money aside for retirement.

There are several budgeting apps that can help you track your spending. Two examples are:

YNAB (You Need A Budget) helps you stay on top of your spending by encouraging you to plan ahead and keep track of every dollar.
PocketGuard is an app that helps you avoid overspending by analyzing your income, bills, and financial goals.

3. Pay Yourself First

One of the most important things you can do is pay yourself first. This means putting aside money for unexpected expenses like medical bills, car repairs, or a loss of income. The ideal emergency fund should cover three to six months of living expenses.

Financial experts recommend saving at least 20% of each paycheck every month. Once your emergency fund is in place, continue saving for other important goals, such as retirement or a down payment on a home.

4. Limit and Reduce Debt

Living within your means is crucial to avoid accumulating too much debt. However, there are times when borrowing can be beneficial, such as when taking out a mortgage to buy a house. If you have debt, prioritize paying it off, especially high-interest debt like credit cards.

For student loans, which make up a significant portion of consumer debt, you may be eligible for various repayment plans. Some federal student loans offer programs like:

Graduated repayment: Monthly payments increase over time.
Extended repayment: Payments are spread out over a longer period, up to 25 years.
Income-driven repayment: Payments are based on your income and family size.

5. Only Borrow What You Can Repay

Credit cards are a common form of borrowing, but they can also become a trap if not used wisely. Always aim to pay off your credit card balances in full every month. If you do carry a balance, try to keep your credit utilization ratio (the amount of your available credit you’re using) below 30%.

Credit cards can also be a useful tool for building your credit score, which is important for obtaining loans, renting apartments, or getting better insurance rates. However, make sure to manage your credit carefully by paying your bills on time.

6. Monitor Your Credit Score

Your credit score is important when applying for loans, mortgages, and other types of financing. A good credit score can help you get lower interest rates and better terms on loans. The most common credit score is the FICO score, which ranges from 300 to 850.

Factors that influence your FICO score include:

Payment history (35%)
Amounts owed (30%)
Length of credit history (15%)
Credit mix (10%)
New credit (10%)

You can check your credit score regularly for free through services like CreditWise or AnnualCreditReport.com, where you can get your free credit report once a year from the three major credit bureaus.

7. Plan for Your Future

It’s essential to plan for the future, including retirement and estate planning. Even if retirement seems far away, starting early allows your money to grow through the power of compounding interest. Experts recommend saving at least 10-15% of your income for retirement.

Additionally, make sure to have important documents in place, like a will and any necessary insurance policies (health, life, disability, etc.). These can help protect your assets and ensure your wishes are carried out if something happens to you.

If your employer offers a retirement plan, like a 401(k), start contributing to it as soon as possible, especially if your employer offers a matching contribution.

8. Buy Insurance

As you age, you’ll accumulate assets and responsibilities, like a family, home, or health issues. Insurance becomes crucial to protect these things and avoid financial ruin if something unexpected happens. Health insurance, life insurance, and long-term care insurance are all important to consider. The younger you are when you purchase insurance, the cheaper it can be.

If you’re the primary earner in your family, life insurance can provide financial support for your loved ones in case of your death.

9. Maximize Tax Breaks

Many people miss out on potential tax savings, which could free up money for savings, debt repayment, or enjoyment. Keep track of your receipts and expenditures to identify potential tax deductions and credits. A tax deduction reduces your taxable income, while a tax credit directly reduces the amount of tax you owe.

Common tax-saving strategies include contributing to retirement accounts (like a 401(k) or IRA), and keeping track of expenses related to your work or home.

10. Give Yourself a Break

While managing your finances is important, don’t forget to treat yourself every once in a while. It’s essential to enjoy life and feel the rewards of your hard work. Whether it’s a vacation, a small purchase, or a fun night out, take time to reward yourself.

Lastly, don’t hesitate to ask for help when needed. If you’re unsure about taxes, investments, or estate planning, hiring a financial professional can help you avoid mistakes and get your financial goals on track.

These strategies can guide you toward a secure financial future. By planning ahead and managing your money wisely, you can achieve financial independence and peace of mind for yourself and your family.

Personal Finance Skills

To get your finances on track, it’s important to use skills you already have. The same principles that help you succeed in business and your career also apply to managing your personal money. Three important skills to focus on are prioritizing finances, evaluating costs and benefits, and controlling your spending.

Finance Prioritization: This means identifying what brings in the most money and focusing on those efforts. By prioritizing your income sources, you ensure that you’re consistently moving toward your financial goals.
Assessing the Costs and Benefits: This skill helps you make better decisions by evaluating the costs of any new venture or idea before jumping in. Instead of spreading yourself too thin with too many projects, assess whether the potential benefits are worth the costs involved.
Restraining Your Spending: One of the most important skills is learning to spend less than you earn. Even if you have a high income, like $250,000 a year, it won’t help if you spend more than that. Controlling your spending on non-essential things is key to building wealth. Focus on saving or paying off debt first before spending on luxury items.

Breaking Personal Finance Rules for Young Adults: When Necessary

The personal finance realm is filled with guidelines, tips, and principles aimed at helping people manage their money wisely. While these rules are useful to understand, it’s essential to remember that everyone’s financial situation and goals are unique. Here are some key rules that prudent people, especially young adults, are often advised to follow—but that can be adjusted or broken if necessary.

1. Saving or Investing a Set Portion of Your Income

Ideal Practice: A common piece of advice is to save 10% to 20% of your income every month for retirement. This is part of a fiscally responsible budget aimed at building wealth over time.
Why It Might Not Always Apply:
- Big Expenses: Young adults often face significant expenses, such as purchasing a car, buying a home, or paying for postsecondary education. Setting aside 10% to 20% of your income could be a substantial setback in meeting these goals.
- High-Interest Debt: If you’re carrying high-interest debt like credit card balances or personal loans (e.g., 19% APR on a Visa card), saving for retirement may not make sense. The returns from a balanced mutual fund portfolio could be offset by the high-interest payments you’d incur.
- Life Experiences: For young people still unsure about their career or life path, saving money to travel, gain new experiences, or explore the world can be incredibly valuable and fulfilling.
Flexible Approach: Instead of rigidly sticking to a percentage, focus on finding a balance that allows you to save while also covering essential expenses, paying down debt, or investing in valuable life experiences.

2. Long-term Investing/Investing in Riskier Assets

Rule of Thumb: Young investors are often advised to adopt a long-term, buy-and-hold strategy and invest in higher-risk assets like stocks, as they have a longer time horizon to recover from potential losses.
Why It Might Be Broken:
- Adapting to Market Conditions: In volatile markets, making short-term adjustments can sometimes be more profitable than sticking rigidly to a buy-and-hold philosophy. If you sense opportunities to minimize losses or capitalize on gains, don’t hesitate to make changes.
- Diversification: The principle of diversification applies regardless of age. It’s important to balance risk and ensure your portfolio is well-diversified, including low, medium, and high-risk assets. This allows you to manage risk without committing to all high-risk investments.
- Long-Term vs. Medium-Term Investments: While the long-term outlook is generally encouraged, if you’re still within the medium term (e.g., 10-15 years away from retirement), you don’t necessarily need to fully invest in high-risk assets. You can strike a balance by diversifying your portfolio across stocks, bonds, and other investment options to ensure you’re protecting your savings while still aiming for growth.
- Preserving Capital in Later Years: Even if you’re still young, there’s no need to take on undue risk in short- to medium-term investments. As you age, you may still want to include growth investments to ensure you have sufficient savings over the long haul.

3. Investing in Riskier Assets for the Long Term

Common Wisdom: Young investors often need to invest in riskier assets to maximize returns. This approach takes advantage of the time horizon, allowing for long-term growth and recovery from market downturns.
Why It Might Be Adjusted:
- Avoiding Unnecessary Risk: You don’t have to go all-in on risky investments. If you’re uncomfortable with high-risk ventures or prefer to diversify, you can balance risk across your portfolio.
- Long-Term Investments Still Work: Even if you’re still in your 20s or 30s, you can still invest in assets that offer growth without going for the highest risk options. A diversified portfolio that includes a mix of stocks, bonds, and index funds can still generate solid returns without undue risk.
- Preserving Capital: If you’re close to retirement (60 or older), you’ll want to cut back on riskier investments, but you don’t necessarily have to do so immediately. Growth investments could still make sense for you in your younger years, provided you’re willing to ride out market fluctuations.

Conclusion

Personal finance is all about managing your money in a way that ensures your expenses are covered and that you’re building savings and wealth for the future. It encompasses several important aspects, such as budgeting, managing debt, saving for retirement, and investing in ways that help you reach your financial goals.

In addition, personal finance involves protecting yourself and your loved ones with insurance and estate planning. Having a solid understanding of personal finance provides the tools needed to live a life free of financial stress, manage unexpected expenses, and make smart choices that lead to long-term financial stability.

At its core, personal finance is a life-planning tool. It helps you make decisions about your money today while ensuring that you can live comfortably in the future. By mastering personal finance, you gain the confidence to handle any financial situation that comes your way and create a secure, debt-free life.