12 Fundamental Principles of Personal Finance
Personal finance is a term that broadly covers anything related to money management, including but not limited to saving, spending, investing. Understanding personal finance can help you lead a financially independent and stress-free life.
This blog’s for you if you’re just starting out on your financial journey. Continue reading to know everything about personal finance, its core principles and more.
What is Personal Finance?
Personal finance can be broadly defined as a financial term that’s often used to refer to money management. This can include investing, saving, spending, etc. It’s imperative to develop good personal finance habits to avoid any kind of financial stress.
Personal finance involves every crucial aspect of finance that needs looking after, such as banking, budgeting, mortgages, insurance, investment, tax and retirement planning. You have to make wise financial decisions to make the most out of your earnings and savings.
5 Areas of Personal Finance
There are five important areas of personal finance that you need to take care of. These areas are:
1. Income
It is the first and basic step in personal finance management, without which the other areas won’t exist. Sources of income depend on the type of employment of an individual: it can be salary, profits, wages, pension and dividends. How you manage these determines the whole process of financial management.
2. Spending
Expenditure depends on your responsibilities and financial freedom. But it should always be done wisely so that the monetary balance is maintained. The major areas of expenses include rent, taxes, food, entertainment or recreational activities and loans or mortgages.
3. Savings
Savings is the most crucial aspect of personal finance management. Savings is not necessarily always the excess after spending but sometimes adjustment too. Savings or investment is mostly made keeping in mind the long-term investment goals, but it is sure to be helpful for emergencies as well. Savings can be done in different methods, out of which banks and mutual funds are the most preferred.
4. Investing
Investing and saving are interchangeable terms. But the main difference between savings and investment is the risk taken. While savings allow you to get lower returns with the minimal risk taken, the investment provides you with higher returns and risk as well. Investment is a part of your savings.
5. Protection
Financial protection is also a part of your savings or investment. It ensures that you and your dependent ones make it through the hard times and unforeseen circumstances without much difficulty. Some of the common protection plans include health insurance, life insurance and mortgages.
12 Fundamental Principles of Personal Finance
Following the basic 12 principles will lead you to successfully manage your personal finances.
1. Know your Take-home Pay
Before you start spending or planning for investment, know how much exactly is going to be your net pay. It will be available to you for spending after all the deductions made from your salary.
2. Pay Yourself First
Before you pay your cheques, keep aside some of your earnings for unexpected situations and emergencies.
4. Start Saving Younger
The interest paid on your savings depends on your savings tenure. The more time you keep investing, the higher the return will be.
5. Analyse Interest Rates
You should check with the financial institutions and compare the interest rates between them to earn more interest while paying less for your debt.
6. High Returns Equal to High Risk
Different investment strategies are available in the market, and some might seem more suitable to you than others. But you should always invest according to your risk appetite. Higher returns will always involve higher risk.
7. Don’t Borrow what You can’t Pay Back
This is one of the crucial aspects of managing your personal finance. Be a responsible borrower and cut your coat according to your cloth. This will also improve your credit score.
8. Keep in Mind the Rule of 72
The rule implies that to know how many years it will take for your savings to double, divide 72 by the rate of interest.
9. Don’t Expect Something for Nothing
You should always remember that nothing comes for free and beware of such promises. There is no return without investment.
10. Budget Your Income
Creating a yearly budget considering all the expected and ensured expenses will make it easier for you to successfully achieve your financial goals.
11. Maintain Your Credit Record
Credit scores against every individual are recorded by credit bureaus. A negative credit score will affect your loan eligibility in future.
12. Stay Insured
Insurance should be the top priority among investments. It is always advisable to stay prepared beforehand.
13. Plan Your Financial Goals
Map both your long-term and short-term financial goals and make realistic plans to achieve them.
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Why is Personal Finance Important?
We all want some freedom with our earnings while taking on financial responsibilities as well. But personal freedom and personal finance go hand in hand. If the question is about how important personal finance is, then it should work as a reminder that you need to look after your finances better than you are currently doing.
Managing personal finances include various aspects such as savings, investment, insurance, taxes, loans and retirement. Personal finance is important for both long-term and short-term financial planning.
Personal Finance Tips
The sooner you start financial planning, the better. It is important to strategise your finances to reach your personal financial goals easily and effectively.
Here are some personal finance tips for better planning:
1. Know Your Income
Before proceeding with a financial plan, you should know exactly how much you will be receiving from one or multiple sources of income. Make sure to calculate your net income after subtracting taxes and other monthly financial obligations, such as EMI.
2. Set a Budget
A Budget is essential to guide you to live within your means and save for long-term financial goals. Ideally, practicing the 50-30-20 budgeting method can prove to be convenient. It looks somewhat like this:
- 50% of net income should be spent for daily essentials
- 30% can be spent for leisurely expenses such as shopping, outing, etc.
- 20% for paying debt, retirement planning and emergency fund.
3. Limit Your Debt
Not spending more than you can pay off is the wisest choice but not the easiest. People may need to borrow money from time to time. But these should be kept in check.
Also, loans can sometimes act as an advantage. One such example could be taking out a loan to buy an asset.
Additionally, use your credit card in a disciplined manner. Spending incautiously can lead to a big debt trap which can be hard to recover from and hamper your credit score significantly.
4. Keep an Eye on Your Credit Score
The credit score is an important aspect of your financial record. Having a good credit score can come in handy in many circumstances.
For example, during some unforeseen situations, the fund required might not be available instantly. At that time, borrowing may be the only option. A low credit score might pose a challenge during such circumstances.
5. Buy Insurance
Insurance is one of the smartest ways of investment. An insurance is a real cost-saving and life-saving device in times of emergencies. Also, expenses for insurance get costlier with age. Hence, buying an insurance policy when you are young can prove to be beneficial.
6. Plan Your Retirement
To protect your assets and your loved ones in your absence, it is essential to plan your finances in advance. Retirement planning when you are young might sound “too soon”, but it is not. Investing in long-term plans or purchasing insurance policies for your and your loved ones is crucial for efficient financial planning.
Final Word
From a very young age, we are taught how to earn. As we start earning, it is equally important to learn what to do with the wealth earned.
Personal finance revolves around planning your finances today so you can have a better tomorrow. Develop good personal finance habits to enjoy a stress-free and financially independent future.
FAQs
Personal finance means the course of planning and managing personal financial activities. This includes earning, spending, saving and investment. Some of the other aspects can include mortgages and risk allocation as per an individual’s financial strategy.
Ans: The 30-day rule is for impulsive buyers. While making a decision about some big purchase, it is advised that you wait for 30 days and see if you still need to go ahead with the decision. Following this rule helps the impulsive buyer not to overspend.
Ans: Embezzlement is the term that refers to a white-collar crime in which an individual does fraud or inappropriately uses a fund entrusted to them. The most common form of embezzlement is cash skimming done by the cashiers.
Ans: IRADA, or the Indian Regulatory and Development Authority, is the autonomous body responsible for managing the insurance industry in India, under which comes both the life insurance and general insurance companies.
Ans: Mortgage protection ensures that the mortgage payments are made in case of the sudden demise of the borrower and that the burden doesn’t fall on the family members or the dependants.
Ans: The basic difference between dividends and profit is that dividends are parts of the profit. When a company earns a profit, it shares the profit earned among the shareholders as dividends.
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