Why is personal finance important
What is personal finance? It is everything in your life that involves money. Personal financial planning is arranging to spend, save, and invest money to live comfortably, have financial security, and achieve goals. Everyone has different financial goals. Goals are the things you want to accomplish. For example, getting a college education, buying a car, and starting a business are goals. Planning your personal finances is important because it will help you to reach your goals, no matter what they are. It is up to you to make and follow a financial plan.
Some of the benefits of planning are:
- You have more money and financial security.
- You know how to use the money to achieve your goals.
- You have less chance of going into debt you cannot handle.
- You can help your partner and support your children if you
- have a family.
Whether you are spending, saving, or investing money, planning can help you to make big or small financial decisions. The financial planning process has six steps to help you reach your goals.
STEP 1: Determine Your Current Financial Situation
To figure out your current financial situation, make a list of items that relate to your finances:
- Monthly income (job earnings, allowance, gifts,
- and interest on bank accounts)
- Monthly expenses (money you spend)
- Debts (money you owe to others)
A good way to estimate your expenses is to keep a careful record of everything you buy for one month. You can use a small notebook to track your expenses. When you have determined your financial situation, you will be able to start planning.
The financial planning process can help you reach your financial goals.Main Idea –
STEP 2: Develop Your Financial Goals
To develop clear financial goals, think about your attitude toward money and ask yourself some questions: Is it more important to spend your money now or to save for the future? Would you rather get a job right after high school or continue your education? Do your personal values affect your financial decisions? Values are the beliefs and principles you consider important, correct, and desirable. Different people value different things.
Needs and Wants: Another important aspect of developing financial goals is knowing the difference between your needs and your
wants. A need is something you must have to survive, such as food,
shelter, and clothing. A want is something you desire or would like to have or do. For example, if you live in an area where the winter is cold, you need a coat. So you may want a leather jacket, but other less expensive coats would also keep you warm.
Only you can decide what specific goals to pursue. For example, you might want to save money. So, you could save $50 every month or 15 percent of every paycheck.
STEP 3: Identify Your Options
It is impossible to make a good decision unless you know all your options. Generally, you have several possible courses of action. Suppose that you are saving $50 a month. You might have these options:
- Expand the current situation. You may decide to increase the amount of money you save every month to $60.
- Change the current situation. You could invest in stocks instead of putting your money into a savings account.
- Continue the same course of action. You may choose not to change anything.
However, in each case, be aware that the costs of your decision may outweigh the benefits.
STEP 4: Evaluate Your Alternatives
In this step, you evaluate your alternatives as part of the financial planning process. Use the many sources of financial information that are available. (See Figure 1.1.) Look at your situation in life, your present financial situation, and your personal values. Consider the consequences and risks of each decision you make.
Sources of Financial Information: It is important to keep up-to-date with social and economic conditions because they can affect your financial situation. For example, a company that manufactures the latest technology or designs the trendiest clothes may be a good investment. On the other hand, if you learn that the company is being sued, would you invest in it?
Consequences of Choices: When you choose one option, you eliminate other possibilities. You cannot choose all the options. Suppose that you want to become a full-time college student. You also want the income you would earn at a full-time job. In choosing to pursue your education, you give up the opportunity to work full time, at least for the moment. An opportunity cost, or a trade-off, is what is given up when making one choice instead of another. The opportunity cost of going to college would be the benefit of having a full-time job.
Information on financial planning can come from many sources:
However, choosing involves more than knowing what you might give up. It also involves knowing what you would gain. For example, by going to college, you could gain a higher-paying job.
If you decide to ride your bicycle in a very busy city street, you are taking a risk of having an accident. When you make a financial decision, you also accept certain financial risks. Some types of financial risks include:
Inflation Risk-If you wait to buy a car until next year, you accept the possibility that the price may increase.
Interest Rate Risk-Interest rates go up or down, which may cost of borrowing or the profits you earn when you save or invest.
Income Risk- You may lose your job due to unexpected health problems, family problems, an accident, or changes in your field of work.
Personal Risk-Driving for eight hours on icy mountain roads may be hazardous. The risk may not be worth the money you would save on airfare.
Liquidity Risk-Liquidity is the ability to easily convert financial assets into cash without a loss in value. Some long-term investments, such as a house, can be difficult to convert quickly.
STEP 5: Create and Use Your Financial Plan of Action
A plan of action is a list of ways to achieve your financial goals. If your goal is to increase your savings, a plan of action could be to cut back on spending. If you want to increase your income, you might get a part-time job or work more hours at your present job. You could use the extra money you earn to pay off debts, save money, purchase stocks, or make other investments.
STEP 6: Review and Revise Your Plan
Financial planning continues as you follow your plan. As you get older, your finances and needs will change. That means that your financial plan will have to change too. You should reevaluate and revise it every year.
There are many software products on the market today designed to help you keep track of your personal finances. One of the first and most popular is Quicken®. Features allow you to track and pay bills and see if you have enough money to cover upcoming bills. You can also schedule bill payments and deposits.
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