What Is Personal Finance?
Personal finance is a term that covers managing your money as well as saving and investing. It encompasses budgeting, banking, insurance, mortgages, investments, and retirement, tax, and estate planning. The term often refers to the entire industry that provides financial services to individuals and households and advises them about financial and investment opportunities.
Individual goals and desires—and a plan to fulfill those needs within your financial constraints—also impact how you approach the above items. To make the most of your income and savings, it’s essential to become financially savvy—it will help you distinguish between good and bad advice and make intelligent financial decisions.
The Importance of Personal Finance
Personal finance is about meeting your personal financial goals. These goals could be anything—having enough for short-term financial needs, planning for retirement, or saving for your child’s college education. It depends on your income, spending, saving, investing, and personal protection (insurance and estate planning).
Not understanding how to manage finances or be financially disciplined has led Americans to accumulate enormous debt. In August 2022, household debt had increased by $2 trillion since December 2019. In addition, the following balances increased from the first quarter of 2022 to the second:
- Credit card balances: Up by $46 billion
- Auto loans: Up by $33 billion
- Consumer loans and store cards: Up by $25 billion
- Total non-housing: Up by $103 billion
- Mortgages: Up by $207 billion
Student loans remained unchanged, at about $1.59 trillion.
Americans are taking on an ever-increasing amount of debt to finance purchases, making managing personal finances more critical than ever, especially when inflation is eating away at purchasing power and prices are rising.
Personal Finance Education
Personal money management isn’t one of the most popular topics in educational systems. Many college degrees require some financial education, but it isn’t geared toward individuals, which means that most of us will need to get our personal finance education from our parents (if we’re lucky) or learn it ourselves.
Fortunately, you don’t have to spend much money to find out how to manage it better. You can learn everything you need to know for free online and in library books. Almost all media publications regularly dole out personal finance advice, too.
Online Blogs
Reading personal finance blogs is a great way to start learning about personal finance. Instead of the general advice you’ll get in personal finance articles, you’ll learn exactly which challenges real people face and how they address them.
Mr. Money Mustache has hundreds of posts full of insights on escaping the rat race and retiring early by making unconventional lifestyle choices.13 CentSai helps you navigate myriad financial decisions via first-person accounts.14 Million Mile Secrets and The Points Guy each teach you how to travel for a fraction of the retail price using credit card rewards. These sites often link to other blogs, so you’ll discover more sites as you read.1516
Of course, we can’t help tooting our own horn in this category. Investopedia offers a wealth of free personal finance education. You might start with our special sections on budgeting, buying a home, and planning for retirement—or the thousands of other articles in our personal finance section. And don’t forget to listen to “The Investopedia Express with Caleb Silver,” our weekly podcast, and sign up for Investopedia newsletters.
At the Library
You may need to visit your library in person to get a library card if you don’t already have one, but after that, you can check out personal finance audiobooks and e-books online without leaving home. Some of the following best sellers may be available from your local library: I Will Teach You to Be Rich, The Millionaire Next Door, Your Money or Your Life, and Rich Dad Poor Dad. Personal finance classics such as Personal Finance for Dummies, The Total Money Makeover, The Little Book of Common Sense Investing, and Think and Grow Rich are also available as audiobooks.
Free Online Classes
If you enjoy the structure of lessons and quizzes, try one of these free digital personal finance courses:
- Morningstar Investing Classroom offers a place for beginning and experienced investors alike to learn about stocks, funds, bonds, and portfolios. Some of the courses you’ll find include “Stocks Versus Other Investments,” “Methods for Investing in Mutual Funds,” “Determining Your Asset Mix,” and “Introduction to Government Bonds.” Each course takes about 10 minutes and is followed by a quiz to help you make sure that you understood the lesson.17
- EdX is an online learning platform created by Harvard University and the Massachusetts Institute of Technology. It offers at least three courses that cover personal finance: “How to Save Money: Making Smart Financial Decisions” from the University of California at Berkeley, “Personal Finance” from Purdue University, and “Finance for Everyone: Smart Tools for Decision-Making” from the University of Michigan. These courses will teach you how credit works, which types of insurance you might want to carry, how to maximize your retirement savings, how to read your credit report, and what the time value of money is.18
- “Planning for a Secure Retirement” is an online course from Purdue University. It’s broken up into 10 main modules, and each has four to six sub-modules on topics such as Social Security, 401(k) and 403(b) plans, and IRAs. You’ll learn about your risk tolerance, think about what kind of retirement lifestyle you want, and estimate your retirement expenses.19
- “Personal Finance” is a free online video course from Missouri State University through iTunes. This basic course is good for beginners who want to learn about personal financial statements and budgets, how to use consumer credit wisely, and how to make decisions about cars and housing.20
Podcasts
Personal finance podcasts are a great way to learn how to manage your money if you’re short on free time. While you’re getting ready in the morning, exercising, driving to work, running errands, or preparing for bed, you can listen to expert advice on becoming more financially secure. In addition to “The Investopedia Express with Caleb Silver,” you may find these valuable:
- The Dave Ramsey Show is a call-in program that you can listen to any time through your favorite podcast app. You’ll learn about the financial problems that real people are facing and how a multimillionaire who was once broke himself recommends solving them.21
- Freakonomics Radio and NPR’s Planet Money both make economics enjoyable by using it to explain real-world phenomena such as “how we got from mealy, nasty apples to apples that actually taste delicious,” the Wells Fargo fake-accounts scandal, and whether we should still be using cash.2223
- American Public Media’s Marketplace helps make sense of what’s happening in the business world and the economy.24
- So Money with Farnoosh Torabi combines interviews with successful business people, expert advice, and listeners’ personal finance questions.25
The most important thing is to find resources that work for your learning style and that you find interesting and engaging. If one blog, book, course, or podcast is dull or difficult to understand, keep trying until you find something that clicks.
Education shouldn’t stop once you learn the basics. The economy changes, and new financial tools like the budgeting apps mentioned earlier are always being developed. Find resources you enjoy and trust, and keep refining your money skills through retirement and beyond.
What Personal Finance Classes Can’t Teach You
Personal finance education is a great idea for consumers, especially people starting out who want to learn investing basics or about credit management; however, understanding the basic concepts is not a guaranteed path to financial sense. Human nature can often derail the best intentions to achieve a perfect credit score or build a substantial retirement nest egg. These three key character traits can help you stay on track:
Discipline
One of the most important tenets of personal finance is systematic saving. For example, say your net earnings are $60,000 per year, and your monthly living expenses—housing, food, transportation, and the like—amount to $3,200 per month.
There are choices to make surrounding your remaining $1,800 in monthly salary. Ideally, the first step is to establish an emergency fund or perhaps a tax-advantaged health savings account (HSA).
To be eligible for a health savings account, your health insurance must be a high-deductible health plan (HDHP).
Establishing an emergency fund takes financial discipline—without it, giving in to the temptation to spend rather than save can have dire consequences. In the event of an emergency, you may not have the money to pay the expenses—leading you to finance them through debt.
Once you have your emergency stash, you’ll need to develop investing discipline—it’s not just for institutional money managers who make their living buying and selling stocks. Average retail investors tend to do better by setting an investment target and abiding by it rather than buying and selling stocks trying to time the market.
A Sense of Timing
Timing can be crucial. For instance, imagine you’re three years out of college, have established your emergency fund, and want to reward yourself. A Jet Ski costs $3,000, but you want to start investing also. “Investing in growth stocks can wait another year,” you say. “I have plenty of time to launch an investment portfolio.”
However, putting off investing for one year can have significant consequences. The opportunity cost of buying a personal watercraft can be illustrated through the time value of money.
The $3,000 used to buy the Jet Ski would have amounted to nearly $49,000 in 40 years at 7% interest, a reasonable average annual return for a growth mutual fund over the long haul. Thus, delaying the decision to invest wisely may likewise delay the ability to reach your goal of retiring at age 65.
Doing tomorrow what you could do today also extends to debt payment. If you were to put the Jet Ski on your credit card, the $3,000 credit card balance would take 222 months (18.5 years) to pay off if you only made minimum payments of $75 each month. And don’t forget the interest you’re paying: at an 18% annual percentage rate (APR), it comes to $3,923 over those months. So, if you were to plunk down the $3,000 to pay the balance rather than let it compound, you’d see substantial savings—nearly $1,000.
Emotional Detachment
Personal finance matters are business, and business should not be personal. A difficult but necessary facet of sound financial decision-making involves removing emotions from a transaction.
Making impulsive purchases feels good but can significantly impact long-term investment goals. So can making unwise loans to family members. Your cousin Fred, who has already burned your brother and sister, will likely not pay you back, either. The smart thing to do is decline his requests for help—you’re trying to make ends meet also.
The key to prudent personal financial management is to separate feelings from reason. However, when loved ones are experiencing real trouble, it pays to help if you can—just try not to take it out of your investments and retirement.
Many people have loved ones who always seem to need financial help—it is difficult to refuse to help them. If you include planning to assist them in real emergencies using your emergency fund, it can make the burden easier.
Breaking Personal Finance Rules
The personal finance realm may have more guidelines and tips to follow than any other. Although these rules are good to know, everyone has their own circumstances. Here are some rules prudent people, especially young adults, are never supposed to break—but can break if necessary.
Saving or Investing a Set Portion of Your Income
An ideal budget includes saving a portion of your paycheck every month for retirement—usually around 10% to 20%. However, while being fiscally responsible is important and thinking about your future is crucial, the general rule of saving a given amount for retirement may not always be the best choice, especially for young people just getting started.
For one thing, many young adults and students need to consider paying for their biggest expenses, such as a new car, home, or postsecondary education. Taking away 10% to 20% of available funds would be a definite setback in making those purchases.
Additionally, saving for retirement doesn’t make much sense if you have credit cards or interest-bearing loans to pay off. The 19% interest rate on your Visa card probably would negate the returns you get from your balanced mutual fund retirement portfolio five times over.
Finally, saving money to travel and experience new places and cultures can be especially rewarding for a young person who’s still unsure about their life path.
Long-term Investing/Investing in Riskier Assets
The rule of thumb for young investors is that they should have a long-term outlook and stick to a buy-and-hold philosophy. This rule is one of the easier ones to justify breaking. Adapting to changing markets can be the difference between making money or limiting your losses and sitting idly by and watching your hard-earned savings shrink. Short-term investing has its advantages at any age.
Common investing logic suggests that because young investors have such a long investment time horizon, they should be investing in higher-risk ventures; after all, they have the rest of their lives to recover from any losses that they may suffer; however, you don’t have to take on undue risk in your short- to medium-term investments if you don’t want to.
The idea of diversification is an important part of creating a strong investment portfolio; this includes both the riskiness of individual stocks and their intended investment horizon.
At the other end of the age spectrum, investors near and at retirement are encouraged to cut back to the safest investments—even though these may yield less than inflation—to preserve capital. Taking fewer risks is important as the number of years you have to earn money and recover from bad financial times dwindles, but at age 60 or 65, you could have 20, 30, or even more years to go. Some growth investments could still make sense for you.
Frequently Asked Questions
What Is Personal Finance?
Personal finance is the knowledge, instruments, and techniques used to manage your finances. When you understand the principles and concepts behind personal finance, you can manage debt, savings, living expenses, and retirement savings.
What Are the 5 Main Components of Personal Finance?
The five main components are income, spending, savings, investing, and protection.
What Is an Example of Personal Finance?
One of the key ideas behind personal finance is not to spend more than you make. For instance, if you make $50,000 a year but spend $65,000, you’ll end up with debt that continues to compound because you’ll be spending more than you make to pay for past expenses.
Why Is Personal Finance So Important?
The concepts behind managing your personal finances can guide you in making intelligent financial decisions. In addition, the decisions you make throughout your life on what to buy, sell, hold, or own can affect how you live when you can no longer work.
The Bottom Line
Personal finance is managing your money to cover expenses and save for the future. It is a topic that covers a broad array of areas, including managing expenses and debt, how to save and invest, and how to plan for retirement. In addition, it can include ways to protect yourself with insurance, build wealth, and ensure wealth is passed on to the people you want it to pass to.
Understanding how to manage your finances is an important life-planning tool that can help set you up for a life without debt; you gain control of financial stresses and have a way to manage the expensive surprises that life can throw at you.
