What Is Personal Finance and How Can It Lead to Financial Security?
What is personal finance? We tackle this broad question and more to help you get on a clear financial path.
Contributing Writer at Tally
September 28, 2021
“Personal finance” has become a bit of a buzzword. The phrase gets tossed around a lot, and depending on its context, it can take on many different meanings.
What is personal finance, and why is it so important to so many people? We’ll cover the basics of what personal finance is here. We’ll also offer some tips to help you get your personal finances in top shape now and in the future.
What is personal finance, and why is it so important?
Personal finance is a broad topic that involves managing all aspects of your, or your family’s, finances and financial decisions. It includes your income, your expenses, your debt and even your retirement. Personal finance is all about planning, budgeting, executing and looking ahead while considering past actions.
Personal finance is such a critical topic because without stable finances, you can fall into a paycheck-to-paycheck cycle that becomes nearly impossible to break. Once stuck in this cycle, you may find yourself scraping together change from the couch cushions to pay for lunch before your next check arrives.
With the proper planning and budgeting, you can break this cycle and meet your short-term and long-term financial goals.
What are the key steps to solid personal finances?
There are countless tips and tricks to help get your cash flow heading in the right direction. While your exact path to stable finances may differ from your neighbor’s, some overarching guidelines could help you along the way.
Creating a budget
Rule number one of financial literacy and building strong personal finances is setting a rock-solid budget.
You can follow any of the numerous budgeting styles, but some of the more popular ones include:
Building a strong budget not only helps you manage your money, it also gives you an honest look at where your money goes. This can quickly expose trouble areas, like how that daily takeout lunch wrings your budget dry.
In the past, setting a budget meant breaking out paper and a pen to manually write expenses and income down or creating a complex Excel spreadsheet to track everything.
Today, there are various apps and software you can use to help with budgeting, including: You Need a Budget (YNAB), Mint and Every Dollar.
With these apps, you attach specific dollar amounts to varying budget categories, like utilities, groceries and dining out. Many of these apps also link to your bank account and automatically import transactions.
You can then review the transactions and apply them to their respective budget category, making it quick and easy to monitor your expenses in each category.
Living below your means
Living expenses take up a massive portion of your finances. You can mitigate these costs by living below your means.
For example, you may be able to afford that $500,000 home with six bedrooms and four bathrooms, but you might want to consider if that is really the home your three-person family needs. Instead, think about a three- or four-bedroom house, which would allow you to apply the cash you save on the mortgage to something else — like repaying high-interest debt or saving for retirement.
Personal finance also involves eliminating debt and managing all future debt. The first step is to pay off all your high-interest rate debts. Personal finance experts commonly agree that any debt with an annual percentage rate (APR) higher than 6% is a high-interest debt.
Generally, your mortgage, student loans and many auto loans will fall below the high-interest mark. However, some personal loans and most credit cards will land squarely inside the high-interest category.
Debt avalanche: This method prioritizes your highest-interest debts and has you apply all your extra money to the highest-interest debt while making the minimum payments on your other debts. Once you pay off one debt, you apply all your extra cash to the next highest interest. You repeat this process until you pay off all your debt.
Debt snowball: This method prioritizes your lowest-balance debts and has you apply all your extra money to the lowest-balance debt while making the minimum payments on your other debts. Once you pay off one debt, you apply all your extra cash to the next lowest balance. You repeat this process until you pay off all your debt.
If you find that you struggle to keep your credit card debt in check, it may be best to leave the credit cards at home and switch to your debit card instead.
Building an emergency fund
Emergencies are a significant contributor to credit card debt. If a big expense arises that you don’t have the funds to cover, you may find yourself taking out a loan or paying with a credit card. Or maybe you lost your job and need to get by with no income for a period — this can also lead to grabbing the credit card.
To avoid this situation, it’s a good idea to build an emergency fund that can cover three to six months of expenses. Start funneling a portion of your paycheck into a savings account until you reach the recommended savings. While the exact amount you can save will vary with your budget, many personal finance experts suggest setting aside 20% of your take-home pay for things like retirement or building an emergency fund.
If you have other financial obligations that you must handle quickly — like paying off high-interest debt — you can save up a $1,000 emergency fund for now, then come back to complete the three to six months of savings after satisfying that obligation.
Watching your credit score
Some personal finance experts think a credit score is a pathway to debt. However, a good credit score can open many pathways you may have otherwise missed. For example, if there’s a significant expense that your emergency fund can’t fully cover, a good credit score allows you to get a loan to handle it.
Also, a good credit score can help you accumulate good debt, such as a mortgage on a home that will likely appreciate over the years.
Watch your FICO credit score carefully each month and address any unexpected changes, like a new account or missed payment, to prevent a credit score decrease.
FICO scores range from 300 to 850, and within those ranges are five categories:
300 to 579: Poor credit
580 to 669: Fair credit
670 to 739: Good credit
740 to 799: Very good credit
800 to 850: Exceptional credit
You can monitor your credit in several ways. One reliable way would be via myFICO.com, but they charge upwards of $29.95 per month for your credit score from all three credit bureaus. You can also try the complimentary route with Credit Karma, Credit Sesame and others, but these are only estimated scores and can vary greatly from your true FICO score.
If you’re more worried about what’s on your credit report than your credit score, you can get one free credit report per year from annualcreditreport.com.
Insuring what you have
You could take steps toward protecting your and your family’s health by enrolling in a quality health insurance plan to cover the bulk of your health care expenses. If your employer offers a plan, they will often pay a portion of the premiums so you can get coverage for less.
When you’re choosing a plan, you’ll want to consider more than just the monthly premium. It’s important to look at the deductibles and out-of-pocket maximums, as those factors will contribute to your overall medical costs.
You also might want to protect the ones you love with life insurance on yourself and your spouse. If one of you dies unexpectedly, the life insurance policy could pay off your family’s debts and possibly leave enough cash to replace your salary.
Planning for retirement
Retirement planning is often the last thing you think about when you’re young, but the years catch up quickly. Soon, you may find yourself in your 40s with little to no retirement savings.
Like most personal finance topics, there’s no shortage of ways to plan for retiring. You can plan for a lush retirement that requires significant sacrifices in your younger years or go for a lean retirement and plan to keep to a stricter budget in your later years.
With many people needing a nest egg that can cover 80% of their highest yearly income, the total amount of money necessary to retire can be substantial. If you earned $100,000 per year, you’d need retirement savings sufficient to cover $80,000 per year.
One rule of thumb says you should withdraw no more than 4% from your retirement savings to cover this salary replacement. That would amount to a $2 million nest egg — which is why retirement is an important long-term goal to start as early as possible.
When setting up your retirement accounts, you’ll want to consider diversifying to ensure you don’t put all your financial eggs in one basket. One way to do this is to have a 401(k), IRA, annuities, stocks and mutual funds. This may help mitigate your losses if one of your investment accounts sees a significant loss.
Getting outside help
Understanding that you don’t know everything about personal finance is also key. You may need to reach out to a professional for help with your financial planning.
Find a financial planner who can help you organize your finances early in life. Sometimes you can find a complimentary certified financial planner through a credit union, but you can also hire one if you aren’t a credit union member.
A financial planner can help you determine how much you need to save for retirement, manage your existing debt, manage your estate planning should you die, plan your taxes and much more. Some can even help you with investing in the stock market.
There are also many personal finance courses you can take online and locally. Some of these courses don’t cost anything, but others may charge a small fee. Before paying for one of these courses, search online to see if free resources cover the same topic.
A far-reaching but important topic
Personal finance is such a broad topic that you’ll likely find that some parts of it are difficult to follow. Understanding personal finance and executing your financial plan starting now are both important for quick and sustained financial success.
There will be bumps along the way, but with a strong grasp of personal finance and your financial plan, you can get back on track and head in the right direction again.
If credit card debt is stifling your financial plan, the Tally† debt repayment app can help. The Tally app not only helps you manage all your credit card bills, it also includes a lower-interest personal line of credit to help you pay off your higher-interest credit card debts quickly.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.