Personal finance
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Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save and spend monetary resources over time, taking into account various financial risks and future life events. Components of personal finance might include checking and savings accounts, credit cards and consumer loans, investments in the stock market, retirement plans, social security benefits, and income tax management.
The financial planning process
The financial planning process is a dynamic process that requires regular monitoring and reevaluation. In general, it has five steps: (assessing your situation, setting goals, crafting a plan, taking action, and monitoring your progress)
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- Assessing your financial situation is usually done by compiling several lists. These lists are simplified versions of corporate balance sheets and income statements. On your personal balance sheet, you list all your assets (e.g., car, house, clothes, stocks, bank account) and give their values. You also list all your liabilities (e.g., credit card debt, bank loan, mortgage) and give their values. Subtracting your total liabilities from your total assets will indicate your personal net worth. To understand how your personal net worth will change in the future, you compile what is called a personal cash flow statement. This lists your income, and your expenses. By subtracting your expenses from your income, you obtain your net cash flow for the period. If your net cash flow is positive, your personal net worth will increase. Most people grossly underestimate how much they spend each year.
- Setting goals gives your life a financial direction. Examples of financial goals are: "To retire at age 50 with a personal net worth of £800,000", or "To buy a house in 3 years paying a monthly mortgage servicing cost that is no more than 25% of my gross income". It is not uncommon to have several goals, some short term, and some long term.
- The financial plan details how you will accomplish your goals. It could include for example, reducing unnecessary expenses, increasing your employment income, or investing in pork belly futures. However you plan to do it, detailed calculations have to be made for each period (usually yearly). The effects of taxation and inflation must be considered.
- When you have decided on the best plan for your goals and circumstances, you implement it. This involves taking specific actions. It often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisors, and lawyers.
- As time passes, it is important to monitor your progress. If it looks like you will not obtain your goal, you can either alter your plan or adjust your goal.
See also
- Accounting software
- Credit card debt
- Debt consolidation
- Equity investment
- Finance software
- Insurance
- Investment
- List of personal finance related articles
- Mortgage
- Wealth
References
- Kwok, H., Milevsky, M., and Robinson, C. (1994) Asset Allocation, Life Expectancy, and Shortfall, Financial Services Review, 1994, vol 3(2), pg. 109-126.