Personal finance


Personal finance is the financial management that an individual or a family unit performs to budget, save, and spend monetary resources in a controlled manner, taking into account various financial risks and future life events.
When planning personal finances, the individual would take into account the suitability of various banking products, insurance products, and investment products, as well as participation in monitoring and management of credit scores, income taxes, retirement funds and pensions.

History

Before a specialty in personal finance was developed, various closely related disciplines, such as family economics and consumer economics, were taught in various colleges as part of home economics for over 100 years.
In 1920, Hazel Kyrk's dissertation at the University of Chicago was instrumental in developing the disciplines of consumer and family economics. Margaret Reid, a professor of home economics at the same university, is recognized as one of the pioneers in the study of consumer behavior and household behavior.
In 1947, Herbert A. Simon, a Nobel laureate, suggested that a decision-maker did not always make the best financial decision because of limited educational resources and personal inclinations.
Research into personal finance is based on several theories, such as social exchange theory and andragogy. In America, professional bodies such as the American Association of Family and Consumer Sciences and the American Council on Consumer Interests started to play an important role in developing this field from the 1950s to the 1970s. The Association for Financial Counseling and Planning Education at Iowa State University and the Academy of Financial Services were established in 1984 and 1985 respectively. AFCPE started to offer several certifications for professionals in this field, such as Accredited Financial Counselor and Certified Housing Counselor. Meanwhile, AFS cooperates with Certified Financial Planner.
Before 1990, the study of personal finance received little attention from mainstream economists and business faculties. However, several American universities such as Brigham Young University, Iowa State University, and San Francisco State University started to offer financial educational programs in both undergraduate and graduate programs since the 1990s. These institutions published several works in journals such as The Journal of Financial Counseling and Planning and the Journal of Personal Finance.
As the concerns about consumers' financial capability increased during the early 2000s, various education programs emerged, catering to a broad audience or a specific group of people, such as youth and women. The educational programs are frequently known as "financial literacy". However, there was no standardized curriculum for personal finance education until after the 2008 financial crisis. The United States President's Advisory Council on Financial Capability was set up in 2008 to encourage financial literacy among the American people. It also stressed the importance of developing a standard in financial education.

Personal finance principles

It is hard to define universal personal finance principles because:
  • Individual situations vary significantly when it comes to income, wealth, and consumption requirements.
  • Tax and financial regulations vary between countries.
  • Market conditions change both geographically and over time.
A financial advisor can offer personalized advice in complicated situations and for high-wealth individuals. Still, University of Chicago professor Harold Pollack and personal finance writer Helaine Olen argue that in the United States, good personal finance advice boils down to a few simple points:
  • Pay off credit card balances every month in full
  • Dedicate 10-20% of post-tax income for savings and investments
  • Create an emergency fund that can last at least 6 months
  • Maximize contributions to tax-advantaged funds such as a 401 retirement funds, individual retirement accounts, and 529 education savings plans
  • When investing savings:
  • * Avoid trading individual securities
  • * Look for low-cost, diversified mutual funds that balance risk vs. reward appropriately to an individual's target retirement year
  • If using a financial advisor, require them to commit to a fiduciary duty to act in an individual's best interest
The limits stated by laws may be different in each country; in any case personal finance should not disregard correct behavioral principles and the diligence of a "good family father": people should not develop attachment to the idea of money, morally reprehensible, and, when investing, should maintain the medium-long-term horizon avoiding hazards in the expected return of investment.

Personal financial planning process

The key component of personal finance is financial planning which is a dynamic process requiring regular monitoring and re-evaluation. In general, it involves five steps:
  1. Assessment: A person's financial situation is assessed by compiling simplified versions of financial statements, including balance sheets and income statements. A personal balance sheet lists the values of personal assets, along with personal liabilities. A personal income statement lists personal income and expenses.
  2. Goal setting: Multiple goals are expected, including short- and long-term goals. For example, a long-term goal would be to "retire at age 65 with a personal net worth of $1,000,000", while a short-term goal would be to "save up for a new computer in the next month." Setting financial goals helps to direct financial planning by determining the parameters and expectations one aims to achieve.
  3. Plan creation: The financial plan details how to accomplish the financial goals set in the previous step. It could include, for example, reducing unnecessary expenses, increasing employment income, or investing in a fixed deposit.
  4. Execution: Execution of a financial plan often requires discipline, perseverance and sacrifice. Many people take assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
  5. Monitoring and reassessment: The financial plan is monitored in regular intervals to determine if one is on track to reach their goals. This information is evaluated to make potential adjustments as time passes and circumstances change.
Typical goals that most adults and young adults have are paying off credit card/student loan/housing/car loan debt, investing for retirement, investing for college costs for children, and paying medical expenses.

Goals for personal finance

In the modern world, there is a growing need for people to understand and take control of their finances because of the following reasons:
1. Lack of comprehensive formal education: Although many countries have some formal education for personal finance, the Organization for Economic Co-operation and Development studies show low financial literacy in areas it is not required, even in developed countries like Japan.
  • Personal finance in public education is not always required, with just under 30% of high schools in the US in 2024 not having personal finance as a graduation requirement.
  • Graduate students with financial educations averaging higher credit scores and receiving more favorable loan conditions.
  • Hence, it is essential to associate the connection of financial courses in the education system and the generational shift of personal financial educations.
This illustrates the importance of learning personal finance from an early stage, to differentiate between needs vs. wants, improve financial literacy, and to build financial planning skills..
2. Shortened employable age: Over the years, with the advent of automation and changing needs; it has been witnessed across the globe that several jobs that require manual intervention or that are mechanical are increasingly becoming redundant.
  • Several employment opportunities are shifting from countries with higher labor costs to countries with lower labor costs keeping margins low for companies.
  • In economies with a considerably large younger population entering the workforce who are more equipped with the latest technologies, several employees in the middle management who have not up-skilled are easily replaceable with new and fresh talent that is cheaper and more valuable to the organizations.
  • Cyclical nature of several industries like automobile, chemicals, construction; consumption and demand is driven by the health of the countries economy. It has been observed that when economies stagnate, are in recession, and in war - specific industries suffer more than others. This results in companies rationalizing their workforce. An individual can lose their job quickly and remain unemployed for a considerable time. All these reasons bring to the realization that the legal employable age of 60 is slowly and gradually becoming shorter.
These are some of the reasons why individuals should start planning for their retirement and systematically build on their retirement corpus, hence the need for personal finance.
3. Increased life expectancy: With the developments in healthcare, people today live till a much older age than previous generations. The average life expectancy has increased even in developing economies. The average life expectancy has gradually shifted from 60 to 81 and upwards, which coupled with a shorter employable age reinforces the need for a large enough retirement corpus and the importance of personal finance.
4. Rising medical expenses: Medical expenses including cost of prescription medicine, hospital admission care and charges, nursing care, specialized care, geriatric care have all seen an exponential rise over the years. Many of these medical expenses are not covered through insurance policies that might either be private/individual insurance coverage or through federal or national insurance coverage.
  • In developed markets like the US, insurance coverage is provided by either the employers, private insurers or through federal government. However, with the rising US fiscal deficit and large proportion of the senior population, it needs to be seen whether the extent of the Medicare program is sustainable in the long run, therapy exclusions in the coverage, co-pay, deductibles - several cost elements are to be borne by individuals continually.
  • In other developed markets like the EU, most medical care is nationally reimbursed. This leads to the national healthcare budgets being very tightly controlled. Many newer, expensive therapies are frequently excluded from national formularies. This means that patients may not have access through the government policy and would have to pay out of pocket to avail of these medicines
  • In developing countries like India, China, most of the expenses are out of pocket as there is no overarching government social security system covering medical expenses.
These reasons illustrate the need to have medical, accidental, critical illness, life coverage insurance for oneself and one's family as well as the need for emergency corpus;.