Personal finance
Encyclopedia
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 account
s, credit card
s and consumer loan
s, investments in the stock market
, retirement plans, social security
benefits, insurance
policies, and income tax
management.
Typical goals most adults and young adults have are paying off credit card and/or student loan debt, investing for retirement, investing for college costs for children, paying medical expenses, and planning for passing on their property to their heirs (which is known as estate planning
).
The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget
Personal budget
A personal budget is a finance plan that allocates future personal income towards expenses, savings and debt repayment. Past spending and personal debt are considered when creating a personal 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 account
Savings account
Savings accounts are accounts maintained by retail financial institutions that pay interest but cannot be used directly as money . These accounts let customers set aside a portion of their liquid assets while earning a monetary return...
s, credit card
Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...
s and consumer loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s, investments in the stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
, retirement plans, social security
Social security
Social security is primarily a social insurance program providing social protection or protection against socially recognized conditions, including poverty, old age, disability, unemployment and others. Social security may refer to:...
benefits, insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
policies, and income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...
management.
Personal financial planning
A key component of personal finance is financial planning, which is a dynamic process that requires regular monitoring and reevaluation. In general, it has five steps:- Assessment: One's personal financial situation can be assessed by compiling simplified versions of financial balance sheetBalance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
s and income statementIncome statementIncome statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
s. A personal balance sheet lists the values of personal assetAssetIn financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s (e.g., car, house, clothes, stocks, bank account), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statementIncome statementIncome statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
lists personal incomeIncomeIncome is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
and expenses. - Setting goals: Two examples are "1. Retire at age 65 with a personal net worth of $1,000,000," and, "2. Buy a house in 3 years while paying a monthly mortgage servicing cost that is no more than 25% of my gross income." Having multiple goals is common, including a mix of short term and long term goals. Setting financial goals helps to direct financial planning.
- Creating a plan: The financial plan details how to accomplish your goals. It could include, for example, reducing unnecessary expenses, increasing one's employment income, or investing in the stock market.
- Execution: Execution of one's personal financial plan often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
- Monitoring and reassessment: As time passes, one's personal financial plan must be monitored for possible adjustments or reassessments.
Typical goals most adults and young adults have are paying off credit card and/or student loan debt, investing for retirement, investing for college costs for children, paying medical expenses, and planning for passing on their property to their heirs (which is known as estate planning
Estate planning
Estate planning is the process of anticipating and arranging for the disposal of an estate. Estate planning typically attempts to eliminate uncertainties over the administration of a probate and maximize the value of the estate by reducing taxes and other expenses...
).
The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:
- Financial position: this area is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all liabilities of the household, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and in what time the personal goals can be accomplished.
- Adequate protection: the analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance. Business owners, professionals, athletes and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.
- Tax planning: typically the income tax is the single largest expense in a household. Managing taxes is not a question of if you will pay taxes, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax. Typically, as your income grows, you pay a higher marginal rate of tax. Understanding how to take advantage of the myriad tax breaks when planning your personal finances can make a significant impact upon your success.
- Investment and Accumulation Goals: planning how to accumulate enough money to acquire items with a high price is what most people consider to be financial planning. The major reasons to accumulate assets is for the following:
- purchasing a house
- purchasing a car
- starting a business
- paying for education expenses
- accumulating money for retirement, to generate a stream of income to cover lifestyle expenses.
- Achieving these goals requires projecting what they will cost, and when you need to withdraw funds. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.
- Retirement Planning: retirement planning is the process of understanding how much it costs to live at retirement, and coming up with a plan to distribute assets to meet any income shortfall.
- Estate Planning: involves planning for the disposition of your asset when you die. Typically, there is a tax due to the state or federal government at your death. Avoiding these taxes means that more of your assets will be distributed to your heirs. You can leave your assets to family, friends or charitable groups.
See also
- Accounting softwareAccounting softwareAccounting software is application software that records and processes accounting transactions within functional modules such as accounts payable, accounts receivable, payroll, and trial balance. It functions as an accounting information system...
- Asset AllocationAsset allocationAsset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.-Description:...
- Asset locationAsset locationAsset location is a term used in personal finance to refer to how investors distribute their investments across savings vehicles including taxable, tax-deferred and tax-exempt accounts , grantor retainer annuity trusts, generation-skipping trusts, charitable remainder trusts or charitable lead...
- Corporate financeCorporate financeCorporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...
- Debt consolidationDebt consolidationDebt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan....
- Equity investment
- Family planningFamily planningFamily planning is the planning of when to have children, and the use of birth control and other techniques to implement such plans. Other techniques commonly used include sexuality education, prevention and management of sexually transmitted infections, pre-conception counseling and...
- InsuranceInsuranceIn law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
- InvestmentInvestmentInvestment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
- List of personal finance related articles
- PensionPensionIn general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
- Personal budgetPersonal budgetA personal budget is a finance plan that allocates future personal income towards expenses, savings and debt repayment. Past spending and personal debt are considered when creating a personal budget...
- Personal finances of professional American athletesPersonal finances of professional American athletesThe personal finances of professional American athletes are so often handled badly that, according to a 2009 Sports Illustrated article, 78% of National Football League players are either bankrupt or in financial trouble within two years of retirement, and an estimated 60% of National Basketball...
- Separately managed accountSeparately managed accountA separately managed account is an individual managed investment account offered typically by a brokerage firm through one of their brokers or financial consultants and managed by independent investment management firms and have varying fee structures...
- Settlement (finance)Settlement (finance)Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against payment of money, to fulfill contractual obligations, such as those arising under securities trades....
- WealthWealthWealth is the abundance of valuable resources or material possessions. The word wealth is derived from the old English wela, which is from an Indo-European word stem...
- Wealth managementWealth managementWealth management is an investment advisory discipline that incorporates financial planning, investment portfolio management and a number of aggregated financial services...