The Ultimate Guide to Personal Finance

Introduction

Personal finance is something that many of us struggle with at times. It could be that we don’t understand it, or we find that it’s too boring. In many instances people feel that its something they need not to concern themselves with as they make/do not make enough money to even bother with it. This post will provide the ultimate guide to what personal finance is, why it’s important to understand and manage it, and how you can get started.

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What is personal finance?

Personal finance is the process of managing the money and financial welfare of individuals and households. It includes goal setting, planning, and management of financial activities that concerns the health of private money affairs. Managing your personal finance is important as it improves and maintains your standard of living. Ultimately, good personal finance management should effectively improve your way of life, and in some ways build wealth.

Five (5) key components of personal finance:

There are five key components of personal finance and are likely to come up in any personal finance and wealth building discussions. These should be properly understood and managed individually.

Income

This is money earned, whether actively or passively, at regular intervals and is used to fund daily living. Managing your income is important as no matter how frugal you are, you still need money for basic needs, and with inflation, the cost of those needs fluctuates. You need to understand your exposure by assessing how much you should be earning to live comfortably, how many streams you earn or can earn from and the timing of these revenues. As much as possible, try to look for ways to increase your income.

Expenses

Money you spend on basic needs and then some. It doesn’t matter how much you earn if you are spending way more. Always, always spend less than you earn, and always borrow what you can afford to pay. You need to know where your money is going, what it is being spent on, and when these expenses are incurred. Know your recurring expenses and plan for big ones.

Savings

Money set aside for a specific need, such as emergencies, home improvement, tuition, investments, major expenses etc. Note: only save for a specific purpose. You can never save your way to wealth!

Investments

Money and/or effort you put into a venture to make more money. This hedges against inflation, builds wealth and ultimately increases your standard of living.

Financial protection

Legal strategy you should be using to protect yourself from risk and manage your potential liabilities and unforeseen financial setbacks. Some ways include:

• Insurances such as health, auto, life, professional etc.
• Family security – proper management of your personal finances not only protects you, but your family as well. It ensures the security of your family should the breadwinner is no longer able to provide for whatever reasons. Some protection includes insurance policies, investment accounts and estate planning. The end results:
  1. Reduces funeral costs, legal costs, potential tax burdens, and protects little ones in the event of your early demise.
  2. Creates and maintains generational wealth.
  3. Ensures there is a successor in interest over your business, personal assets and other estate.
• Retirement planning – Many people plan their finances in the short-term. Also, many people don’t accurately calculate how much they need to retire and save based on estimates. You need to properly plan for your future based on current expenses with periodic reviews as your circumstance changes.

The Benefits of properly managing these key components (The importance of personal finance)

Cash Flow management

By managing your income and expenses, you can have an overview of what’s coming in and what’s going out, and most importantly, when these monies are coming in and going out. This is your cash flow. At all times your cash flow needs to be in a surplus and the timing of pay-outs versus when you get paid keeps this in check. Example, let’s say you get paid fortnightly but have monthly bills that are due at different intervals during the month. You may want to straddle your bills across the two pay periods even if one pay period can in fact cover all your bills. This straddling is not to promote irresponsibility (you should always pay your bills on time). It just prepares you for an emergency.

Emergency management

Having a contingency plan and savings provides a cushion for when ‘life’ happens.

Debt management

Ok, so please avoid consumer debt as much as possible. However, there may be times when you need more money than what your disposable income can afford at the moment. Are you able to save for it? Or do you need to borrow money? Understanding the relationship between your income and expenses helps you to minimize risks, and pay off that pesky consumer debt that needs to be cleared already.

On another note, you may not want to avoid debt altogether. Credit cards do have their perks (travel points, cashbacks, etc.), but be cautious and use them responsibly.

Future proof your finances

You want to ensure the security of your loved ones and yourself (retirement planning) as discussed above, and understanding how to maneuver these components provide just that.

Personal finance skills everyone needs

To properly manage the five components of personal finance, there are a few skills/knowledge that you need to have under your belt:

Understand what personal finance is not

Personal finance management is not the same as wealth building/management. Both seek to improve your standard of living, but there are key differences between them. Personal finance is the management of your financial affairs ensuring that you can cover your expenses, retire comfortably, secure your family and hedge against contingencies. In other words, personal finance focuses on cash flows.

Wealth building is a facet of personal finance but focuses more on net worth and accumulating assets.

Discipline

Discipline is a skill that cannot be stressed enough. Knowing what to do is one thing, but do you have the strength of mind to do what you must?

Cost-benefit analysis

It is easy to measure quantitatively how much something costs, but often the benefits may or may not be easily measured. Can we evaluate the value we’ll receive from something? You may be trying to save money on something that may cost you more in time, convenience, or health. A simple checklist can determine if the cost of an expenditure is worth it.

• Is this something I need?
• Will the cheaper alternative achieve the same result?
• Will the alternative take up too much time? Can I afford that time?
• Is this durable? How long before I need to replace it?
• Will this add to my personal or professional development?

This list is not exhaustive but should assist in assessing the value of something.

Ability to prioritize

Prioritization is the ability to separate your needs from your wants. You should be able to tell what must be paid now, what is important, and what can be delayed, and what is not important or doesn’t need to be paid.

Ability to negotiate

The ability to negotiate can earn or save you more money, if done properly. And we don’t mean negotiating $5 off of your bill at the farmer’s market. You want to negotiate on something that will provide additional income per month. Some areas include:

• Negotiating a better salary at a new job, or a raise at your current one
• Negotiating with your car dealer, which will help to reduce your monthly car payments
• Negotiating a better mortgage rate or rental payment
• Furniture – you can ask for free delivery or negotiate the terms of a hire purchase agreement so you would pay fewer monthly fees. In other circumstances, you may even ask for discounts when buying more than one piece of furniture.
• Negotiate on income-generating assets. Remember, “the profit is in the purchase, not the sale”.

Basic legal and compliance skills/knowledge

There are certain basic legal skills that everyone should have, especially when it comes to managing your finances. And no we are not sending you to the bar. But understanding basic legal rights in key areas of your life reduces your exposure. Areas includes:

• Consumer protection rights
• Home
• Your rights as a homeowner/landlord
• Your rights as a renter
• Mortgaging a home
• Property rights regarding expansions, events, etc.
• Place of business
• Rights as an employee/employer
• Redundancy laws
• Overtime, breaks, etc.
• Tax laws – deductibles, compliance, entitlement, Vat
• Compliance for business owners (home office or otherwise)
• Insurance – homeowners, auto, medical
• Will and estate planning
• Financial accounts – understand what happens to your bank accounts when you die, as well as individual institution’s terms of services, charges and fees.
• Always read the fine print once you are entering into any contract.

How to get started with personal finance

Develop the right mindset

So there’s always a million and one reasons we can’t get started with our Personal finances – too boring, it’s complicated, I make/don’t make enough money. Personal finance is for everyone, and once we get rid of limiting beliefs and retrain our brain, we should be able to understand it better.

Understand your why

You need to understand your purpose, what it is you want to achieve and why you want to achieve it.

Define your purpose

Personal finance is, well, personal. It means different things to different people. It does have an emotional component, and that is ok provided that your emotions are properly managed. This means that you acknowledge how you feel, and how you want to feel, but not let those feelings cloud your judgment or put you in a worse-off position. Any decision-making surrounding your finances should be intentional and strategic. Everybody has different why’s, and by extension different goals. Is your end goal to:

• Be able to save enough money for retirement.
• Leave a legacy for your kids.
• Build wealth
• Visit a different city every year
• Go on vacation with my family at this place, or every x number of years

Define your what

This is where you make your objectives more measurable.

• How much money do you need to retire, and at what age?
• You want your kids to be able to attend college without student loans.
• You want to build enough wealth for ‘x’, by accumulating ‘y’ number of resources.

Set goals

Divide your goals into short-term, mid-term and long-term ventures. What do you want to achieve within a year, within 5 years, and within 20 years? Ensure that your goals are S.M.A.R.T, i.e.

• Specific – your goals must be clear and specific rather than vague and general. It must answer who, what, when, where and why. An example of a general goal is I want to have a little savings for a rainy day. A more specific goal is to save six or 12 months’ worth of expenses as contingencies.
• Measurable – ensure that your goal has an indicator for when you have reached it. It should answer the question of how and should be quantifiable. How will I know when I have reached my goal? By what attribute do I determine my progress? Example, I will save $X per month for the next 7 months towards my emergency fund.
• Attainable – ensure that your goal is attainable. Can you realistically achieve your goals with the resources (skill, time, money) you have? Can I reasonably save this amount per month toward my emergency fund given my current income and obligations? Is a side hustle possible with my current responsibilities to level up my monthly savings?
• Relevant – how does this goal fit into your overall objectives and visions for the future?
• Timely – goals must be time-bound. Example, I need to save 6-12 months’ worth of expenses. This can be input-driven or output-driven. What do we mean by this? An output-driven time-bound goal is to save 6-12 months’ worth of expenses by x date. However, in order to achieve that, you will need to save a specific amount of money per week, which may not be attainable due to your current obligations. As such, you will need to shift your focus on a more input-based goal, which in this instance, is to save $x amount of dollars per week.

Develop a plan

Now that we’ve set goals, we need to make a financial plan. How will you achieve your goals?

Evaluate your position

Before making a plan, you need a starting point, and that is to determine your current situation. There are two ways you can achieve this:

• Create a cash flow statement for the last couple of months (don’t overthink this). A cash flow statement is merely a list of all the monies that you’ve received, and all that you’ve spent for the period in question. Its best to start here if you’ve never created a budget before as this gives an idea of your spending habits. If you can’t remember everything that you’ve spent money on, just write the basics. This still gives an idea of the proportion of income that is spent on incidentals, which still gives a good assessment of your money habits.

A positive cash flow is a sign of good financial habits and means that you are spending less than you earn.

A negative cash flow however means that you are spending more than you earn. This is an indication that you have credit card debts, and personal loans to cover your expenses. While things like sickness and lawsuits may force you into situations like these, the more probable culprit is poor financial habit.

• Determine your net worth. Your net worth is simply how much you own (assets) minus how much you owe (liabilities). Assets are resources we own that have a potential economic benefit, even if we never sell those items. These can include a house, Jewelry, etc. Liabilities are things like consumer debt, mortgages, loans, etc.

A positive net worth, like a positive cash flow indicates good financial health, as your assets are greater than your liabilities.

A negative net worth indicates poor financial standing as you have more obligations than you can afford to repay.

Determine your income allocation

Some people use the 70/20/10 rule, while others use the 50/30/20. This allocation is simply how much you spend based on needs, wants and savings. Look through your cash flow statements, see what needs to be cut and derive a realistic allocation considering your essentials first.

Create a budget

Once you’ve weeded out what you can cut back on, create a budget. Start with the basic needs, then move onto other categories. It’s good to have a category for self-development and growth, if you have the resources. Some ideas for growth budget are business events, books/book subscription, training, coaching, online courses, conferences etc. Note, a budget does not restrict your spending, it gives permission on what to spend on. It’s ok to buy something nice once in a while, as long as there are no repercussions later on.

A key thing to note is to look at expenses beyond months when doing your budget. For quarterly and annual expenses such as insurance, do a monthly average of the cost and budget that money each month.

Set up different funds based on your goals

Set up sinking funds according to your goals. A sinking fund is a place to save money for a specific goal. An example is to have different accounts for home improvement, car savings, retirement, college for the kids, vacation, tuition and the list goes on. It may be too cumbersome to have a different bank account for every goal that you have, and so an easier way is to categorize each fund and have an account for these categories. Alternatively, you can have separate saving accounts and saving programs for the major ones such as tuition and retirement; then have one other account for all other goals, and pro rate the fund.

When it comes to expenses, there are few people who have a card for gas and groceries, one for bills, one for subscriptions and another for other types of expenses. Some people are more traditional and use one card for online payments, and the envelope system for in-person transactions. Whatever your process, compartmentalizing helps to see the bigger picture and keep track of your goals.

Take action

Now that you have clarity on what personal finance is and what it means to you, it’s time to execute your plan. Download our personal finance starter pack, inclusive of templates and worksheets to jumpstart your goals.

Track, review and update

Your financial plan should be dynamic and change as your circumstance changes without losing sight of the end goal. Track your progress, periodically revise each stage and make amendments if necessary. To illustrate, if your income has increased, your savings should also be increased. If you normally spend 70% of your expenses on essentials, an increase in your income could potentially allow you to spend only 50% of your expenses on needs.

Educate yourself continuously

Here’s a bonus tip, educate yourself continuously to stay ahead of the game. If you are struggling, read blogs, listen to podcasts, have discussions within relevant communities, and if all else fails, get professional advice from service providers in respective micro areas such as credit cards, insurance, tax planning etc.