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What Are the 4 Areas of Personal Finance
What are the 4 areas of personal finance that are most important for being financially stable? Do you struggle with personal finance? Are you overwhelmed with all the information available online?
There’s a lot of conflicting advice out there about how to manage your finances. Some say to save as much as possible, while others tell you to spend every cent you earn. But what do YOU care about?
In this post, I’ll share the top 5 areas of personal finance I’m most concerned about. Then I’ll explain why these are important to me, and finally, I’ll share my thoughts on whether saving vs spending should be your primary focus.
What is Personal Finance?
Personal finance is managing personal financial activities like income generation, spending, savings, investing, and protection of assets. A person’s financial situation can be described in terms of his/her net worth. Net worth is defined as the total value of everything owned minus liabilities. In simple words, it is the sum of our assets minus debts.
A financial plan is a written document that describes how you want your money to grow over time. Financial plans are used to help people achieve their goals. They usually include objectives, targets, strategies, and timelines.
Income generation is the amount of money earned from employment and investment sources. Income includes wages, interest, dividends, rents, royalties, capital gains, pensions, social security payments, alimony, child support, unemployment compensation, worker’s compensation, etc.
Spending is the act of buying goods and services. Spending is influenced by income and credit limits. Saving is the opposite of spending; it involves reducing consumption levels. Savings can be done in many ways, including bank deposits, stocks, bonds, mutual funds, real estate, insurance policies, etc.
Investing is putting resources into something with a chance of earning profits. Investing differs from speculation because you know what you are getting yourself into. Investments can be made through stock markets, bond markets, commodities, property, venture capital, etc.
Protection of assets is the process of safeguarding against loss. Assets can be physical items like cars, houses, furniture, jewelry, artworks, antiques, collectibles, etc., or intangible items like reputation, goodwill, intellectual properties, patents, copyrights, trademarks, brands, etc.
Areas of Personal Finance
Personal finance is managing personal financial activities such as generating income, spending money, saving, protecting assets, and investing. Personal finance aims to achieve financial goals while maintaining good credit and staying out of debt. A financial plan is a roadmap to achieving those goals.
A financial plan includes setting a realistic budget, creating a savings account, paying debts, and building up investments. These are some of the most important steps toward reaching financial independence.
Income
Income is a source of cash inflow an individual receives and uses to support themselves and/or their family. This could come from various sources, including salaries, bonuses, hourly wages, commissions, tips, royalties, dividends, interest, etc. There are over 300 different types of income that we receive each month.
The most common type of income is salary. A salary is paid regularly, such as $1000 per week or $100 per hour. Other examples include commission-based sales jobs, where you earn a percentage of every sale; hourly wage jobs, where you work a set number of hours per day, week, or month; and fixed-pay jobs, like monthly rent.
Another common type of income is a bonus. Bonus is extra money given out at the end of a fiscal quarter, usually because of good performance. For example, a company might give you a bonus of $5000 at the end of the third quarter just for working hard during the second half of the quarter.
Hourly wages are another form of income. You can think of hourly wages as similar to commission-based sales jobs, except it’s one-time. If you worked 40 hours in a single week, you would be paid $1000.
Finally, royalty payments are a special type of income. Royalty payments typically occur when someone owns something that produces income. For example, if I owned a car dealership, I would receive a royalty payment whenever someone bought a car from my dealership. Another example of royalty payments would be if I wrote a book about how to start a successful business. When people read the book, I would receive a small royalty payment.
Spending
Spending is what you do with the money you earn. Whether it’s paying rent, taxes, or mortgage, it’s all part of your monthly budget. You might think you spend your monthly paycheck on things like food, gas, and clothing, but many purchases are investments in yourself. For example, you could buy a car, pay off student loans, or save up for retirement.
The majority of most people’s incomes go toward spending. In fact, according to the Bureau of Labor Statistics, about 80% of Americans’ total income goes toward spending. This is why it’s important to understand how much you’re spending each month. If you want to start saving some extra money, you’ll need to know where your money is going.
Saving
Savings are important because they allow you to save money without worrying about immediate needs. You don’t want to use up all your resources now because you’ll have nothing left later. For example, if you save $100 per month and spend $50 weekly, you still save $50 weekly. However, if you spent $200 per week, you’d run out of money faster. This is why it’s important to set aside money for long-term goals like retirement.
Investing
Investing relates to purchasing or selling assets to produce a rate of return. Some people invest for fun, others do it because they want to make some extra cash, while others invest because they believe in the long-term value of certain investments.
While there are many different investment vehicles, most involve buying something — usually stocks, bonds, real estate, or commodities — and waiting for the asset to increase in price.
When you buy a stock, bond, or commodity, you essentially purchase part ownership of the asset. You are hoping that the asset will appreciate, allowing you to sell it later for more than what you paid for it.
Protection
Personal protection refers to various products that can guard against unexpected and adverse events. These products can take many forms, including life insurance, health insurance, estate planning, etc.
Common protection products include:
Life Insurance – A form of financial protection that benefits designated beneficiaries upon death.
Health Insurance – Provides coverage for medical expenses incurred during one’s lifetime.
Estate Planning – Ensures you provide for your family members following your passing.
This is another area of personal finances where people typically seek professional assistance, which can become quite complex. Several analyses must be performed to properly evaluate an individual’s protection and estate planning needs.
For example, actuarial tables must be reviewed to determine how much life insurance is required to meet an individual’s needs. Additionally, it is important to consider the impact of inflation over time and the tax implications associated with certain investment strategies.
Why Is Personal Finance Important?
Personal finance is a vital part not just of managing your day-to-day financial needs but also of planning your financial future. Understanding how to manage money effectively can help you avoid problems later on.
By understanding the elements of personal finances, you can better understand the opportunities to improve your finances, whether saving for a rainy day, building up an emergency fund, or preparing for retirement. You can also use this knowledge to plan for long-term financial objectives such as buying a home or starting a family.
How to Become Better Educated in Personal Finance
There is a wealth of information for anyone interested in learning more about personal finances. From nonprofits like Credit Karma and LearnVest to for-profit companies like Wealthfront and Betterment, there are many options for those looking to become better educated in personal finance.
In addition, there are online courses and in-person classes – often for a fee – from for-profit organizations such as the American Institute of Certified Public Accountants, the Financial Planning Association, and the National Association of Personal Financial Advisors.
Resources for Learning About Personal Finance:
Check with your local library, community college, university, or Continuing Education Program about personal finance classes near you.
Benefits of Personal Finance
Feeling in control
Financial well-being is one of the three pillars of happiness, health, and relationships. And while we know that people with lower incomes are less happy than those who earn more, it turns out that even among those who make six figures, there are different degrees of financial well-being.
In our research, we found that people who felt like they had control over their finances — whether that meant paying their bills on time, saving money, or knowing how much money they had each week — reported feeling happier than those without such feelings of control.
We asked participants what being financially secure meant to them, and here’s what they said:
– “Having the ability to meet my basic needs.”
– “Not worrying about running out of money.”
– “Knowing that I don’t have to work overtime to pay off debts.”
– “Being able to afford fun things.”
Capacity to Absorb a Financial Shock
What Are the 4 Areas of Personal Finance Summary
In conclusion, personal finance is a broad term that encompasses many different areas of money management. There are four main categories of personal finance: saving, investing, spending, and debt.
Each area has its rules and regulations but combined, they form a powerful toolkit for achieving financial freedom. I also like to include income and protection because they, too, are very important in your overall personal financial situation.