Understanding “Why is personal finance important?” can bring you closer to a life with more wealth, balance, and happiness.
It’s essential to understand because it’s a myth that you need to be a high-income earner to reach financial independence.
The truth is that earning a high income can make you financially independent in less time. However, you can also achieve this goal even with average income levels. Many people worldwide have done it before!
“All you need to do” is to understand the importance of personal finance activities and do proper financial planning with your money.
Let’s jump into this great topic and learn about the fundamentals 😉
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Purpose of personal finance – Why is it important?
Personal finance is teaching you how to handle your financial situation and how can you establish a life of wealth in the future. Be able to finish your goals!
Before going to the activities you should do, keep in mind that some of the wealthiest people today, didn’t start their path having a lot of money. They have made their fortune with smart financial planning in relation to their savings and spending habits, as well as patience for their wealth to grow with compound interest. They knew that personal finance is very important.
The well-known and one of the most successful investors, Warren Buffet, has been quoted very often when it comes to managing finances and investments. I will state two of his most famous quotes. The first quote is:
“The most important investment you can make is yourself.”
The quote speaks for itself. The importance of enriching your knowledge and your skills is the money best spent. In terms of personal finance, the best investment would be to invest in your financial literacy and your knowledge in personal finance. You are actually already making great progress since your reading my blog 🙂
This investment can make your life better in the long-run, make you able to follow the 7 steps plan, and help you make smart financial decisions.
The second quote is:
“If you don’t find a way to make money while you sleep, you will work until you die.”
For this reason, it is especially important not only to keep control of your expenses but also to make money work for you with opportunities such as P2P lending, Real estate crowdfunding and Index funds.
Now let’s understand the activities … ⚔️
Personal finance activities
Personal finance is important because it’s considering a variety of activities related to your finances and how to best manage them.
The activities can help you to be a more financially responsible person and to develop financial discipline.
The one activity that is most important is your budgeting.
Budgeting is considering everything from your income, through your savings and spending habits, up to retirement planning.
I use a simple excel sheet on my laptop where I update monthly. This gives a really good overview, shows where the money is going and helps me stay focused on my personal goals. You can also use some free apps on the phone but you really need to have a budget.
Imagine how many celebrities or high paid athletes have filed for bankruptcy. You must have wondered how the heck they are bankrupt when they were making millions of dollars. The answer is straightforward, lack of financial planning and very, very, lousy budgeting decisions.
Understanding your total income
Income and spending are two starting points when it comes to personal finance. You can’t do progressive and life-changing financial planning if you don’t understand your income and spending habits.
Income is the money you make from your employment and maybe also side-job or side-hustle but also profit from your investments.
Typical during the early stages of your employment your income is low. Later on, it will increase until your retirement. During retirement, your income will consist of the profit you make from your investments.
However, it doesn’t mean it has to be that way. That’s just the typical way for most people 🙂
Be aware of your total income (including fluctuations) will enable you to make better budgeting decisions. Then you can have an overview in terms of the amount of money you are saving and investing, how much you are spending on stuff and how much debt you can afford and whether you need debt at all.
This can help you take control back, make your own plan and build up the life you wish. Exciting right? 🤩
Keep control over your spending habits
This is tough for many people but if you are out of control with your spending, you could end up in a situation with serious financial problems with a lot of insecurity.
Spending habits can have a very negative impact on your financial health and put an end to a more enjoyable life.
I have allocated money for consumption every month. I have a smaller amount for myself that can spend on what I want and a smaller amount for activities with my wife. In this way, I make sure to minimize and consider my consumption. If I consume too much then that amount will be deducted the next month.
Spending the entire monthly income (or the biggest part of it) is quite negative for you because you won’t have money aside to cover for unexpected expenses or unforeseen activities or investment opportunities.
The worst case is if you start to accumulate debt because of your spending habits. Then you have a serious problem that needs to be addressed with a strict budget but also personal support.
The need for an emergency fund
This is also really valuable…
If you don’t have an emergency fund it will create financial insecurity. It’s highly important to have.
There is always a chance that some unforeseen expenses could occur sometime in your lives (car broke down, suddenly becoming unemployed, fixing your home, etc.).
Such a situation could be easily overcome if you have set aside a certain level of cash. The cash which you have saved for “rainy days” is called an emergency fund or reserve fund.
I have also established an emergency fund that can cover 6 months of expenses. This money is used not for investment but for creating a good financial foundation.
Imagine for a second that you have to make some major damage repairs in your house. Where would you find money to cover the repairment cost? If you have an emergency fund, then you can use this money and fix the issues, without any financial stress.
But what happens if you don’t have an emergency fund. Then you will become stressed out because you need to find the money. The basic choices are to borrow from friends and relatives, borrow from a bank, or sell something you own. If you borrow money, you will increase your debt levels. Moreover, if you borrow money from a bank or other financial institution, you will have to pay the cost. Thus, not only you will spend money to fix your problem, but also, your problem now becomes more expensive because of the interest rate you pay to your bank.
Let me ask you, do you know how to select a loan and the cost of a loan?
You should understand that the quoted interest rate is not representing the full cost of the loan. The total cost of the loan is reflected in the Annual Percentage Rate (APR), which is also provided by the financial institution.
If you have loans then I suggest you check these up and see if the agreements can be improved. I contacted my bank and got a lower interest rate on my mortgage. I simply just asked them and compared with the market trends.
Dealing with different loans
The average debt amount owned by families (age 35 to 65) is from $65,000 up to $108,000. It is crazy that some people over the age of 65 still have debt obligations 😮
Avoiding such a situation is possible and doable, but you would need to find the most suitable strategy for paying off your debt.
For example, debt consolidation could be beneficial in a situation when you have different loans, and you are barely making your monthly payments. Then you will be able to make your payments on time, but also you can even be able to save a certain amount of money each month.
Avoid credit card debt
One of the commonly misused, not to say abuse, financial instruments is the credit cards…
Credit cards are one of the most expensive financial products (for you) offered by financial institutions. They are rather easy to get and even easier to max them out.
It’s not uncommon for someone to have accumulated a large amount of credit card debt. The average credit card debt balance for a family in the United States is actually massive $8,284.
Imagine the cost of these families if you consider that financial institutions can charge an interest rate from 10% and upwards. It’s crazy 😮
For instance, in Britain, credit card holders can pay 24% (APR) for the outstanding balance. Not paying on time the minimum monthly payments on your credit card could result in an even higher cost. In some countries, the penalty rate can reach 29.99%.
Savings opportunities and planning for the future
When you have money aside (savings), you can invest this money in various types of investments. For example, you can be inspired by my personal investment portfolio and read more about the opportunities.
Investing your money can help you over time. It can increase the total income and improve your financial situation. Furthermore, it can help you reach your life goals and be a part of your long-term “retirement” plan.
When we are younger, we tend to ignore the fact that we may need to have a sufficient level of money in the future.
Being young, we assign different priorities in our lives. In the beginning, the foremost priority is to live our lives, have fun, travel, and enjoy everything life has to offer. Afterward, our priority would be to get married and enjoy the beauties of the married life. At some point in our lives, we will need to start planning for retirement.
If you don’t plan for your retirement, you could be faced with low-income levels. Moreover, you will have to give up much of the pleasures which you had during high-income periods. Therefore, personal finance is important because it will enable you to understand the importance of planning for the future.
Planning for your future can also help you with the goal of becoming financially independent (Just like me). You could even retire earlier and enjoy your life to the fullest.
It’s a matter of taking charge of your own life and use your earned money wisely as the tool to enjoy life to the fullest.
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