Personal finance is the process of planning and managing personal financial activities such as income generation, spending, saving, investing, and protection.
The process of managing one’s personal finances can be summarized in a budget or financial plan. This guide will analyze the most common and important aspects of individual financial management.
When planning personal finances, the individual would consider the suitability to his or her needs of a range of banking products (checking, savings accounts, credit cards and consumer loans) or investment private equity, (stock market, bonds, mutual funds) and insurance (life insurance, health insurance, disability insurance) products or participation and monitoring of and- or employer-sponsored retirement plans, social security benefits, and income tax management.
Gross annual income refers to all earnings before any deductions are made, and net annual income refers to the amount that remains after all deductions are made.
The concept applies to both individuals and businesses generation, spending, saving, investingInvesting: A Beginner’s GuideCFI’s Investing for Beginners guide will teach you the basics of investing and how to get started.
Learn about different strategies and techniques for trading, and about the different financial markets that you can invest in., and protection.
The process of managing one’s personal finances can be summarized in a budgetTypes of BudgetsThere are four common types of budgeting methods that companies use: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based. The or financial plan. This guide will analyze the most common and important aspects of individual financial management.
Areas of Personal Finance
In this guide, we are going to focus on breaking down the most important areas of personal finance and explore each of them in more detail so you have a comprehensive understanding of the topic.
As shown below, the main areas of personal finance are income Remuneration is any type of compensation or payment that an individual or employee receives as payment for their services or the work that they do for an organization or company.
It includes whatever base salary an employee receives, along with other types of payment that accrue during the course of their work, which, spending, saving, investing, and protection. Each of these areas will be examined in more detail below.
Income refers to a source of cash inflow that an individual receives and then uses to support themselves and their family. It is the starting point for our financial planning process.
Common sources of income are:
- Hourly wages
- DividendsDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend.
These sources of income all generate cash that an individual can use to either spend, save, or invest. In this sense, income can be thought of as the first step in our personal finance roadmap.
Spending includes all types of expenses an individual incurs related to buying goods and services or anything that is consumable (i.e., not an investment). All spending falls into two categories: cash (paid for with cash on hand) and credit (paid for by borrowing money). The majority of most people’s income is allocated to spending.
Common sources of spending are:
- Mortgage paymentsMortgageA mortgage is a loan – provided by a mortgage lender or a bank – that enables an individual to purchase a home. While it’s possible to take out loans to cover the entire cost of a home, it’s more common to secure a loan for about 80% of the home’s value.
- Credit card paymentsBest Buy Credit CardA Best Buy credit card is a form of credit offered by Best Buy to its loyal customers for purchasing products and services. Learn the types, how to apply, benefits, interest rates, etc. By using their offered credit card, customers can have an easier and faster way of paying for their purchases.
The expenses listed above all reduce the amount of cash an individual has available for saving and investing. If expenses are greater than income, the individual has a deficit.
Managing expenses is just as important as generating income, and typically people have more control over their discretionary expenses than their income. Good spending habits are critical for good personal finance management.
Saving refers to excess cash that is retained for future investing or spending. If there is a surplus between what a person earns as income and what they spend, the difference can be directed towards savings or investments. Managing savings is a critical area of personal finance.
Common forms of savings include:
- Physical cash
- Savings bank account
- Checking bank account
- Money market securitiesMoney MarketThe money market is an organized exchange market where participants can lend and borrow short-term, high-quality debt securities with average maturities of one year or less.
Most people keep at least some savings to manage their cash flow and the short-term difference between their income and expenses. Having too much savings, however, can actually be viewed as a bad thing since it earns little to no return compared to investments.
Investing relates to the purchase of assets that are expected to generate a rate of return, with the hope that over time the individual will receive back more money than they originally invested. Investing carries risk, and not all assets actually end up producing a positive rate of return. This is where we see the relationship between risk and return.
Common forms of investing include:
- StocksStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms “stock”, “shares”, and “equity” are used interchangeably.
- BondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period.
- Mutual fundsMutual FundsA mutual fund is a pool of money collected from many investors for the purpose of investing in stocks, bonds, or other securities. Mutual funds are owned by a group of investors and managed by professionals. Learn about the various types of fund, how they work, and benefits and tradeoffs of investing in them
- Real estateReal EstateReal estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc.
- Private companiesPrivate Company Valuation3 techniques for Private Company Valuation – learn how to value a business even if it’s private and with limited information. This guide provides examples including comparable company analysis, discounted cash flow analysis, and the first Chicago method. Learn how professionals value a business
- CommoditiesGuide to Commodity Trading SecretsSuccessful commodity traders know the commodity trading secrets and distinguish between trading different types of financial markets. Trading commodities is different from trading stocks.
Investing is the most complicated area of personal finance and is one of the areas where people get the most professional advice. There are vast differences in risk and reward between different investments, and most people seek help with this area of their financial plan.
Personal protection refers to a wide range of products that can be used to guard against an unforeseen and adverse event.
Common protection products include:
- Life insurance
- Health insurance
- Estate planning
This is another area of personal finance where people typically seek professional advice and which can become quite complicated. There is a whole series of analysis that needs to be done to properly assess an individual’s insurance and estate planning needs.
The Personal Finance Planning Process
Good financial management comes down to having a solid plan and sticking to it. All of the above areas of personal finance can be wrapped into a budget or a formal financial plan.
These plans are commonly prepared by personal bankers and investment advisors who work with their clients to understand their needs and goals and develop an appropriate course of action.
Generally speaking, the main components of the financial planning process are:
- Plan development
- Monitoring and reassessment
Personal Finance Budget – Example
Preparing a budget or a financial plan is critical for giving you the best shot at achieving your personal and family goals. Below is an example of a simple monthly budget Monthly Cash Flow Forecast Model With a rolling monthly cash flow forecast model, the number of periods in the forecast remains constant (e.g., 12 months, 18 months, etc.). that could be used to manage your income, expenses, savings, and investments.
Read Also: The 5 Types Of Financial Statement
As you can see in the example below, there are three potential sources of income (salary, bonus, and other), followed by a list of expenses (rent, food, groceries, restaurants, entertainment, childcare costs, vacations, etc.), and the difference between the two is the person’s monthly surplus or deficit.
If you’d like to use this free template to help you with your personal finances and planning, please download the Excel spreadsheet and edit it as appropriate to fit your own needs. Additionally, you should always consult a professional advisor before making any financial or investment decisions.
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Personal Finance Careers
There is a wide range of careers that relate to personal financial management and advice. If you’re passionate about any of the topics mentioned in this guide, you may want to consider a career in the industry.
Some of the most common careers include:
- Personal bankerPersonal Banker Job DescriptionPersonal bankers offer help in managing and overseeing the financial needs of a client’s personal bank account. Personal Banker Job Description details include Aid customers in opening, managing and optimizing their bank accounts and other products, pursue leads and potential customers
- Wealth manager
- Investment advisor
- Insurance advisor
- Tax advisor
- Estate planner
- Financial planner
- Mortgage broker
To learn more about the different careers in finance, visit CFI’s interactive Career Map to explore options on the corporate side of the industry. Some of the most common jobs on the corporate side include investment banking, private equity, and corporate development.
Thank you for reading this CFI guide to personal finance. We hope it has helped you understand what managing personal finance is all about, why it’s important, and how to go about doing it.
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CFI’s mission is to help anyone become a world-class financial analyst and have a meaningful career. To help you in your journey, you’ll find these additional CFI resources helpful:
- Corporate FinanceCorporate Finance OverviewCorporate finance deals with the capital structure of a corporation, including its funding and the actions that management takes to increase the value of
- Public FinancePublic FinancePublic finance is the management of a country’s revenue, expenditures, and debt load through various government and quasi-government institutions. This guide provides an overview of how public finances are managed, what the various components of public finance are
- Return on Investment (ROI)Return on Investment (ROI)Return on Investment (ROI) is a performance measure used to evaluate the returns of an investment or compare efficiency of different investments.
- Salary GuidesCompensationCompensation and salary guides for jobs in corporate finance, investment banking, equity research, FP&A, accounting, commercial banking, FMVA graduates,