Knowing personal finance basics is crucial to living a good life. Taking charge of your money is critical for personal success, so it pays to understand how to master money well and use it to accomplish your goals. From savings to budgeting to investing, there are many essential elements to master regarding personal finance.
With banking basics, you learned about financial institutions and the different accounts and services available. In this article, I want you to understand personal finance basics. These are fundamental money concepts that will revolutionize the way you manage money. It will also help you mitigate future financial stress. Financial knowledge supports better decision-making.
To manage your money well, you first have to earn it. Earning income can come in many forms, from a full-time job to a small business, creative gigs, and passive income. We all have one primary income source, but it’s a good idea to have multiple income streams so that if one source dries up, you always have others.
In addition to your primary source, which is a job for most people, it helps to earn additional funds on the side. Some people moonlight as freelance graphic designers or work as dog walkers on the weekend. How you make money is unimportant, but the key is to ensure that you have continuous income.
A budget allocates your financial resources towards your expenses and goals. It helps you see where you are spending and whether you need to cut costs or increase your savings. The first step in budgeting is to write down each monthly expense and compare that to your monthly income.
Find the best budgeting apps for beginners.
Ideally, it would help if you were consistently spending less than you earn. Create categories for regular expenses that occur each month (rent, car payment, cell phone, etc.) and those that occur periodically (gifts, taxes, fees). Your budget helps you to get a handle on what you’re spending each month.
Building an emergency fund is one of the most critical elements of personal finance because it acts as an insurance policy for your earnings. If you have budgeted your money down to the penny, what happens if you have an emergency expense? Your dog swallows a toy, and the vet is charging $2,000 to remove it. Your car needs new brakes, and it will cost $500 to replace them.
By having an emergency fund, you can cover unexpected expenses without touching your budget items. Your emergency fund will include 6 to 9 months of living expenses. Ideally, the fund is held in a savings account that you can access in an emergency but not accessible for other expenses.
Other essential personal finances include saving, investing, and credit.
In addition to your emergency fund, having a savings account allows you to accomplish specific short and mid-term financial goals–typically between 1-5 years. Saving up for large purchases like a down payment on a house, a new car, or a small business can take years, so developing a savings plan is vital.
Savings accounts are also helpful for short-term financial goals like buying holiday gifts, replacing furniture, or getting a medical procedure. Include your savings as a regular expense in your budget and pay into each month the same way you pay for your cell phone bill, rent, or car insurance.
When you save money that earns interest, then you’re investing. Investing in the stock market may offer higher returns with more significant risks. But learning to invest is essential in creating wealth.
An investment account will not only provide you with a place to “park” your money but a way for it to grow. Investment accounts allow your money to grow either through interest, dividends, or growth of share price. Allowing your funds to grow over time with automated and consistent investing can help you passively grow wealth.
Find the best online brokerage accounts for beginners here.
One of the most critical yet misunderstood concepts in personal finance is interest and how it can help or hurt you. The interest payment is like rent paid on your money. When you save money in an interest-bearing account, the bank essentially pays you to keep your cash there each month.
How much rent you earn depends on the interest rate that the bank is paying. Basic savings accounts typically pay the least amount of interest, while other types of savings accounts may pay a bit more. And the more cash and the higher the interest rate, the more you earn. The key is to let it sit and let compound interest work its magic.
Conversely, paying interest can quickly add up, causing you to pay much more than your initial investment. When you purchase a car and pay 5% interest each month, you’re paying for the cost of the vehicle plus the additional interest each month. The longer it takes for you to pay off the car, the more you end up paying for it. The key to avoiding this is to pay off primarily high-interest debts as quickly as possible.
Your credit score is your virtual “report card” of how well you’re doing with financing. It shows potential creditors how much of a “risk” you are when it comes to lending, and it makes all of the difference in the amount of interest you pay for loans. If you plan to buy a car, your credit score will hold a lot of weight, so it pays to stay on top of your credit and understand how the scoring system works.
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The factors that impact credit scores include the history of on-time payments to your creditors, the length of time you have managed credit, and the type of credit you use. Your credit score will determine how much money you may borrow to achieve other financial goals like buying a home.
Consider that a person with a low credit score will pay as much as $100 more a month for a car loan than a person with a high credit score. Over the life of a five-year loan, that adds up to $6,000 in interest payments alone. This $6,000 is money that is not available for your emergency fund, long-term savings, or investing. If you had saved that extra $100 a month in your investment account in a stock plan (stocks traditionally earn about 7% interest annually), you would have more than $7,500 at the end of the 5-year car loan.
Low credit scores mean that you pay more for loans, may have to pay higher deposits for specific items, or be denied credit outright. Check your credit annually to protect your finances.
Congrats! You’ve just read personal finance basics.
Want to learn more?
I suggest reading the best personal finance numbers to know and to familiarize yourself with the first stage of the financial wellness roadmap–financial literacy.