What is Personal Finance?

The personal finance realm impacts every part of life but is rarely taught. When you learn some of these skills, managing your finances can become more accessible and benefit you.

Defining Personal Finance

"Personal finance" encompasses how you manage your money, including:

• Income: Money received regularly from work, investments, or business activities.
• Savings: Money set aside from income for future use or emergencies.
• Discretionary Expenses: Non-essential spending on items like entertainment and dining out.
• Investments: Money put into assets like stocks, bonds, or real estate to earn a return or increase in value.
• Debts: Money borrowed that must be repaid, such as loans and credit card balances.
• Retirement Accounts: Accounts like 401(k)s and IRAs are designed to help save for retirement with tax benefits.

Additionally, there are many aspects to the personal finance roadmap:

• Banking: Financial services provided by banks, including savings, loans, and payment processing.
• Retirement: The period when one stops working, typically supported by savings, pensions, and retirement accounts.
• Savings: Money set aside for future use or emergencies, typically held in a bank account.
• Debt: Money borrowed that must be repaid, such as loans and credit card balances.
• Real Estate: Property consisting of land or buildings, often bought as an investment.
• Taxes: Required payments to the government on income, goods, and activities to pay for public services and infrastructure.
• Estate Planning: Preparing for the transfer of assets after death, including wills and trusts.

These can make personal finance management intimidating to many. However, you can learn about personal finance. Once you start, it can become more accessible to set individual or family goals, pay down debts, and boost retirement savings.

Your finances can impact many areas, such as savings, loan interest rates, and retirement timing. Understanding as much personal finance as possible will benefit you long-term.

Why Is Personal Finance Important?

Personal Finance encompasses how you manage your money and cash flow, including whether you can afford a home, what interest rates you get on loans, and when you retire. We're faced with daily financial decisions—from simple problems, such as whether you should buy lunch every week at work, to more complicated decisions, such as estate planning for future generations.

The better you manage your finances, maintain a good credit score, and limit your debt, the easier it may be to accomplish your goals. That's why becoming financially literate and making the most of your money matters.

Understand Your Baseline

To begin learning essential financial management, the first crucial step of the financial planning process is assessing your current financial situation.

Starting with a baseline gives you a comprehensive view of your finances, allowing you to determine if spending cuts are necessary or if extra money is available for investments or retirement.

A spreadsheet or an online tool can help you track your finances effectively. Reviewing your numbers at the end of each month will prepare you to start setting financial goals.

Set Financial Goals

Creating financial goals becomes easier once you have a clear picture of your current financial situation. 

Here are some common financial goals to consider in your financial planning process:

• Paying off credit card debt
• Paying off a student loan or medical expenses
• Creating an emergency fund
• Buying a home
• Saving for a wedding
• Saving for your kid's college tuition
• Saving for retirement
• Saving for a vacation

Knowing when you want to hit your goals can help when you start creating a budget. Creating a timeline may be helpful for each goal you set. For example, long-term goals like retirement could last decades, while short-term goals, like saving for a vacation next year, have shorter timelines.

Stick to a Budget

Starting with personal finance often begins with setting a budget. A budget is critical for managing your money, as it simplifies financial management and goal tracking. With your monthly budget in place, managing your money and tracking your goals becomes more accessible, and your budget will determine whether you can afford a purchase.

Starting can be simple: Use your baseline spreadsheet or one of many online personal budgeting apps. These do most of the hard work for you and alert you if you need to spend more money. By making small, positive changes to your budgeting method over time, you can move closer to financial security and reach your financial goals.

Build an Emergency Fund

According to a Federal Reserve survey, nearly 37% of Americans would have to borrow funds or could not pay if they were hit with an unexpected $400 expense.¹ Another study by Bankrate found that 27% of Americans either have less or no emergency savings compared to the previous year.²

These numbers highlight the importance of having an emergency savings fund. It's something else you'll want to consider building into your budget. Many experts suggest saving about three to six months of expenses for an emergency fund.

Your list of monthly living expenses may include:

• Mortgage or rent payments
• Monthly bills
• Food
• Gas

The goal is to financially survive an emergency, such as job loss, for a while. Keep your emergency fund a liquid asset in a savings or money market account for easy access.

A rainy-day fund is similar to an emergency fund. It could help cover minor emergencies like new car tires or a vet bill.

Pay Down Debts

For some, debt is a significant barrier to reaching financial goals and retirement savings. Having a lot of debt strains one's plans and goals and can cause mental and emotional stress. 

Learning how to manage your debt is essential for overall financial health. Your financial snapshot can help; knowing what to pay down first requires a complete picture of your total debt. That can feel scary at first. But, once you know the numbers, you can use your budget and money skills to create a plan and set debt reduction goals

There are varying types of debt, including:

Credit Card Debt

According to Experian, a central credit bureau, the average American has approximately $6,500 in credit card debt spread across multiple cards and an average credit utilization ratio of 29%.³ Many people need help with credit cards because they charge too much and fail to pay off their balance each month. With some cards having high interest rates, paying only the minimum monthly can lead to thousands of dollars in extra interest annually. Keeping your credit utilization ratio below 30% is essential, too, because a high ratio may harm your credit score.⁴ Paying off high-interest short-term debt first can help to prevent it from turning into long-term debt.

Student Loan Debt

A recent study found that 42.8 million borrowers have federal student loan debt, and the median amount of debt for those who still owe is between $37,000 to $40,000.⁵ Significant student loan debt can impact various financial decisions, from buying a home to retirement savings. It's important to include student loan payments in your budget plan to avoid falling behind and accruing late fees.

Car Loan Debt

Experian found that the average American has just over $23,000 in outstanding car debt.⁶ Another report from Kelly Blue Book found that the average transaction price for a new car in early 2024 hit over $47,000, with a 3.5% decline since the previous year.⁷ A car loan is typically considered a short- to medium-term debt, so you want to track it in your budget. If you have extra money each month, consider putting additional money toward your car loan to help pay it off sooner. The Consumer Financial Protect Bureau has some good advice on borrowing and negotiating a car loan.⁸

Mortgage Debt

For many, the most significant expense and long-term debt they'll have is a mortgage. It's a serious financial responsibility you'll be paying it off for decades. According to Experian, in 2023, the average mortgage debt was approximately $244,498.^9. Budgeting for your mortgage is essential to any basic financial planning. Your mortgage is likely where the bulk of income goes each month, and your emergency fund should cover several months of mortgage payments in case of job loss or inability to work.

Another option is a mortgage refinance, which could help you reduce your monthly payment. The key is to create a plan and prepare for the long term. Steadily chipping away at it each month can add up over time, and reducing your debt can open up many new possibilities — and help to reduce stress.

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Plan for Retirement

It is never too early or too late to start planning for retirement. After decades of working, retirement is a time to enjoy a well-deserved break and explore new opportunities.

A key goal in younger years is to build up your retirement savings. However, as you get older and closer to retirement, you'll also want to create a retirement budget to ensure it aligns with your goals and expectations. For example, planning to spend your early retirement years traveling will require more than someone planning to stay at home with their grandkids.

A retirement budget helps you see how much money you'll need each month to cover your expenses, and you can compare that with the income your savings may provide. Working with a financial professional or planning service before you retire can help you effectively plan your retirement income and savings goals.

Save and Invest Your Money

The key to making the most out of your retirement is building up as much savings as possible. You can do that in various ways, such as building up your savings, investing in the stock market or focusing on retirement savings accounts.

As you create your ideal budget, look for ways to add to your savings every month. Even small contributions can add up over the years. Compound interest and a favorable rate of return could potentially make a big difference for those who start making investment decisions when they're 25 compared with those who start at 45.

Forms of investing include:

• Add to your Social Security benefits:
  • Qualified retirees can claim Social Security benefits. These benefits are paid out every month and constitute a portion of many Americans' retirement income. The amount you'll get is based on the highest-earning 35 years of income generation. Adding even a year or two of higher income can boost your Social Security payout when you retire. According to AARP, 61% of Americans are worried they won't have enough saved for retirement.¹⁰ The Social Security Administration has resources to help you learn more.¹¹
• Maximize your 401(k): Many workplaces offer employer-sponsored retirement plans, such as a 401(k). These accounts are tax-advantaged, meaning your contributions come from your pretax income. However, these funds will be taxed upon distribution. If you're contributing to your 401(k), the money will be deducted from your salary before you get your paycheck. Some employers also offer contribution matching, which matches contributions you make up to a certain percentage or dollar amount — essentially free money. Remember that any tax-deferred funds will be taxed upon distribution.
• Open an IRA: Regardless of whether you have an employer-sponsored retirement plan, you can consider opening your individual retirement plan (IRA). Many people with 401(k)s also open them to increase their retirement savings opportunities. Opening an IRA is relatively easy and can be done online. Once you have your account set up, allocate money from your budget for your IRA. Review your entire savings plan annually to adjust and maximize savings opportunities, improve your rate of return, and reduce risk.

Focusing on your long-term investment goals and future investing strategies can help you better prepare for a comfortable and secure retirement. 

Consider Your Insurance Needs

You might wonder what joint protection products such as insurance have to do with planning for your future. Insurance — from life insurance to long-term care insurance — is tied to your finances and is a form of personal protection. So, you'll want to factor these costs throughout your life, especially as you get older.

Many Americans receive employer-provided health insurance through work. However, providing health insurance may become necessary as more people strike out independently or work for small businesses. If so, you'll need to budget for those costs.

Another type of insurance to consider is life insurance, which provides a financial cushion for your beneficiaries during your death. The death benefit from your life insurance can cover costs such as a mortgage, student loans, tuition, and childcare. Life insurance could leave your family with income replacement or the burden of paying your debts. 

If you're worried about the cost, life insurance is generally more affordable than you might think. Research from LIMRA shows that over half of Americans overestimate the cost of life insurance by three times its actual price.¹²

As you set your budget, remember to add insurance costs . Beyond health and life insurance, factor in your car, homeowners' insurance, or renters insurance if you have it, too.

Stay on Top of Taxes & Estate Planning

It's not always easy to think about what you want to happen to your financial resources when you're gone, but estate planning is essential to long-term basic financial plan development.

Estate planning lets you transfer your assets and wealth to your loved ones, including your home, life insurance, and savings accounts. The most common way to do this is by setting up a will to specify your wishes for your assets.

Working with a financial planner and an attorney can help you learn about various options for protecting and transferring your assets and advise on the best ways to maximize taxes on your wealth and assets now and after you're gone.

Taxes are another crucial part of your finances. Every year, you have to prepare for tax season. So, could you include it in your regular financial checkup? You can also work on maximizing your deductions by increasing the amount you put into your 401(k) and other tax-advantaged savings vehicles, such as a Health Savings Account.

Budget for Buying a Home

Another personal finance concept includes any real estate holdings you might own. Buying a home is one of the most significant financial decisions you'll ever make, and it will stay with you for a long time, so it's not something to take lightly.

Your budget becomes a crucial tool as you prepare to buy a home. Use it to review your debts and income, see how much money you can afford, and find ways to save for a down payment. Consider all the costs of owning a home and factor that into your budget. During and after the buying process, a list of expenses you may have to pay include:

• Closing costs
• Taxes
• Bank fees
• Upkeep and Maintenance

Working with a qualified real estate agent and mortgage broker will help you answer critical questions.

Review Finances Consistently

Remember, your budget is a living document. As your finances change, so should your budget. Set aside time every quarter or six months to review it and make adjustments, or revisit it immediately if you have any significant life changes.

Regularly reviewing your finances can help you stay on track and foster a habit of planning for your future. Consider big purchases before spending and whether you want to add more debt. Developing actionable plans during these reviews can make managing your finances more effective and goal-oriented.

Keep Learning Personal Finance Basics

Understanding and managing money is a lifelong process. As you learn more about your finances and become more comfortable with them, you can adjust your approach and explore complexities without feeling overwhelmed.

Currently, you're working on building your confidence and a solid foundation of personal finance education that will serve you well in the future. If you want more help in your learning journey, read personal finance articles, take courses, or consider working with a financial professional, whichever fits your learning style. They can serve as a partner and a guide to personal finance, helping you build a better financial future.

   Create a solid personal finance plan with steps toward your goals. Get My Free Financial Review  

Sources

1. Economic Well-Being of U.S. Households in 2023. https://www.federalreserve.gov/publications/files/2023-report-economic-well-being-us-households-202405.pdf.
2. Bankrate's 2024 annual emergency savings report. https://www.bankrate.com/banking/savings/emergency-savings-report/.
3. Average Credit Card Debt Increases 10% to $6,501 in 2023. https://www.experian.com/blogs/ask-experian/state-of-credit-cards/.
4. Credit card utilization and your credit scores. https://www.creditkarma.com/credit-cards/i/credit-card-utilization-and-your-credit-score.
5. Student Loan Debt Statistics. https://educationdata.org/student-loan-debt-statistics.
6. Average Auto Loan Debt Grew 5.2% to $23,792 in 2023. https://www.experian.com/blogs/ask-experian/research/auto-loan-debt-study/.
7. Average New Car Price Tumbling. https://www.kbb.com/car-news/average-new-car-price-tumbling/.
8. Auto loans. https://www.consumerfinance.gov/consumer-tools/auto-loans/.
9. Average US Mortgage Debt Increases to $244,498 in 2023. https://www.experian.com/blogs/ask-experian/how-much-americans-owe-on-their-mortgages-in-every-state/.
10. Majority of Americans over 50 worry they won't have enough money for retirement: Study. https://www.usatoday.com/story/money/2024/05/02/affording-retirement-costs-americans-survey-aarp/73530103007/.
11. Social Security in retirement. https://www.ssa.gov/retirement.
12. U.S. Life Insurance Need Gap Grows in 2024. https://www.limra.com/en/newsroom/news-releases/2024/u.s.-life-insurance-need-gap-grows-in-2024.