Personal Finance Economics

Are you broke? Actually, a better question is: Do you feel broke? It's a funny thing. We live in a world where many people live paycheck to paycheck and "feel broke". But here's the cool part. Even if you feel broke, you may not be broke at all. That said, if you are truly lacking in financial assets and are actually "broke", a few simple steps can put you on a path to long-term wealth. Would you like to learn what those steps are? Read on!

Feeling Broke, Pixabay

Personal Finance Definition

What exactly is the personal finance definition?

Simply put, it's both a snapshot of your financial state as well as a mindset of how to best manage your money and other financial tools like income, debt, budgeting, credit, savings, and investments on an ongoing basis.

And the sooner you adopt a healthy financial mindset, the sooner you'll put yourself on a path to financial stability and never have to feel broke again.

In this explanation, we will examine key components of personal finance including:

• Income
• Savings and Investments
• Checking accounts
• Spending/Budgeting
• Credit and Credit Scores
• Insurance
• Taxes

Types of Personal Finance

Examples of personal finance include:

• Income
• Savings and Investments
• Checking accounts
• Spending/Budgeting
• Credit and Credit Scores
• Insurance
• Taxes

Before we go any further, however, let's discuss the two most important types of personal finance:

• Income, and;
• Savings and Investments

Income

The truth is, without any form of income, well...you won't have to do much personal finance. At least not in the form in which this explanation is framed.

Income can come from different places. Generally speaking, there are two types of income: Passive Income and Active Income.

Passive income is defined as money earned in a manner that does not require too much effort or isn't directly linked to the amount of time you put into generating the income. An example of passive income is the interest you earn on money deposited into a savings account.

Active income is defined as money earned as a direct result of duties or services performed by an individual for a specific set of tasks during a specified duration of time. The most common example of active income is a salary or wage from a job.

Saving and Investments

Savings and investments are both excellent sources of passive income, assuming you don't trade assets daily as your primary source of income.

Savings income comes in the form of interest earnings from savings accounts, or savings bonds.

Investment income comes from the appreciation of the price of stocks, dividends paid to stockholders, and interest paid to bondholders.

An excellent practice to improve personal finance is to take a certain percent of your post-tax earnings and invest that money directly into a savings account or other asset like a stock or bond as a firm practice without exception.

Checking Accounts

Unlike savings accounts, checking accounts are more suited for transaction payments since they're easily accessible and don't generate much interest.

While checking accounts aren't quite as liquid as cash itself, it is a much more convenient and safe way to store transactional funds.

An excellent practice to improve personal finance is to have a system to ensure that your outflows (withdrawals) out of your checking account never exceed your inflows (deposits). Many successful people use online software or spreadsheets to monitor their checking account balances on a daily or weekly basis.

Budgeting

Budgeting is a powerful tool successful people use to take control of their money and wealth. A budget is a spending plan or forecast of upcoming income and expenses. Put another way, a budget is a detailed view of where and when income is expected to come from and expenditures are expected to occur over a certain period of time such as a month or a year.

The simplest way to create a budget is to write down all of your expenditures over a period of time, such as a month, regardless of how small the expenditure is.

Generally, there are 2 types of expenditures:

1. Regularly recurring and predictable expenditures, and;
2. Non-specific or unpredictable expenditures that can take various forms

Regular recurring and predictable expenditures include things like:

• Car payments
• Loan payments
• Rent or mortgage payments
• Utility bill payments
• Insurance payments (e.g., car or life insurance)
• Cell phone payments
• Internet service payments
• Gym membership payments
• Groceries

Non-specific or unpredicted expenditures include things like:

• Unplanned car maintenance
• Non-specific entertainment or social activity expenditures
• Unanticipated product or service purchases
• Unplanned online purchases
• Impulse expenditures

When you create a budget, you write down all of the expenses you incur over the span of a month, including the amount and timing of all regularly recurring and predictable expenditures you incur as well as an estimate for non-specific or predictable expenditures you might incur as well as the general timing for when you might incur them (for example, on weekends).

Then you map out your expected income inflows and when you expect them to occur, and voila! You now have a working budget that will tell you what your net balance of cash and assets is, and also allows you to look at ways to alter your spending patterns, or reduce expenditures on non-necessary products or services.

Credit and Credit Scores

Credit and Credit scores play very important roles in your personal finance economics. Successful people use credit and credit scores to improve their ability to receive a loan or credit card, while less successful people let credit take control over their lives by using credit to purchase products and services they can't afford in the present, so they can slowly pay those expenditures off in the future.

Generally speaking, obtaining credit is the process of borrowing money from a bank or credit card company. In exchange for agreeing to lend you their money, banks and credit card companies charge you interest on money borrowed and spent such that, in the end, you end up paying back more than the amount of credit you obtained. In many cases, you end up paying much, much more than the amount of credit you obtained.

However, in order to be considered as a good candidate to receive their credit, banks and credit card companies look at your creditworthiness by looking at your credit score and credit history.

This is where the successful and unsuccessful take different paths.

Financially successful people use the credit mechanism to establish and optimize their creditworthiness and credit score. They do so by taking out loans or obtaining credit cards and using them in a calculated way, ensuring they use portions of their credit and pay their credit dues back on time every time.

Financially unsuccessful people view credit as "free" money that they can use to buy things. This group of people generally use credit to spend more than they have and, in some cases, more than they make. This can result in late payments, defaults, or maximized credit balances, which drastically impairs their creditworthiness and makes it much more difficult to obtain loans for important things like a car or house.

Insurance

Insurance is an important aspect of personal finance. In some cases, insurance is a requirement by local government authorities (e.g., car insurance), and in other cases, it's an optional, but very valuable "safety net" and asset (e.g., life, health, home).

In its simplest terms, insurance is a regular payment you make to insurance companies to make sure they provide you financial protection in the event of unforeseen expensive events such as a car accident, a home fire, a hospital stay, or if you become disabled somehow.

Taxes

Taxes are largely inevitable. You will pay taxes if you ever buy anything or if you ever make income. Hopefully, for you, both of those things occur.

In order to properly understand your personal financial health, you'll need to account for both types of taxes.

For example, when you budget for grocery expenditures, it would be silly to only budget pre-tax costs since you will definitely have to pay some amount of sales tax on the items you buy.

Conversely, in order to budget effectively, you will have to use your post-tax income as the amounts you budget as your inflows. If your budget is based on pre-tax income, you may very well find yourself in a negative cash position because taxes will reduce your take-home income.

Some employers do a good job of estimating the amount of income you will have to pay at the end of the year given your earnings and personal circumstance, deduct the corresponding amounts from your earnings, and remit those amounts to local and federal tax agencies on your behalf such that when your income taxes are due, you will likely be in a position where you don't have to pay anything additional, and in some cases, you may receive a tax refund in the event your company overpaid the actual amount of taxes due from you.

If your employer doesn't deduct and remit estimated taxes on your behalf, you will have to do that for yourself so that, when your income taxes are due, you'll have the funds to pay them.

Example of Personal Finance

As a high school student, you yourself are a good example of personal finance.

Let's assume you're either lucky enough to get a regular allowance or stipend from your parents, or you have to work for income either by doing chores around the house or taking a part-time job.

Either way, the steps you take to think about and plan your personal finances will set you up for a lifetime of difficulty or harmony.

Now let's assume that you earn, on average, $100 in post-tax income every week. Let's look at the best way to manage this income (going forward we'll just refer to income as post-tax and not mention the other deductions, but remember they're still occurring).

The first thing you should do is take a percentage of that income, and put it directly into a savings account or investment asset such as a stock or bond. Let's assume you decide that 20% is a reasonable amount to put into one of these vehicles.

You now have $80 to spend for the remainder of the week, so the next thing you should do is create a budget.

In order to do this, you should look at exactly how you spent your earnings in the previous week, and maybe even the week before.

Let's assume you determine that, last month, your expenditures looked as follows:

Table 1. Creating a Weekly Budget

As you can see from Table 1, you only spent $76 last week, which explains the $4 in your checking account.

Let's now assume that you can reasonably expect your expenses this week to resemble your expenses last week, with one exception. It's your mom's birthday this Wednesday and you want to buy her a card and some flowers.

You estimate that these items will cost $25. What do you need to do in order to balance your budget next week? You will have to decide which expenditure item(s) you will have to reduce or eliminate this week. Since your regular recurring expenses are essentially off-limits, that means you'll have to reduce or eliminate an unpredicted expense.

Since you enjoy having dinner with your friends, you decide that under no circumstance will you buy anything online this week because you want to buy your mom flowers and a card for her birthday.

Let's look at what your expected weekly budget might look like as illustrated in Table 2 below.

Table 2. Creating a Weekly Budget

As you can see from Table 2, you've done such a good job budgeting your week, that you now have $6 in your checking account! But again, be aware that if your income is above the minimum threshold for your tax bracket, you will need to set aside money to pay income taxes the following April because your parents aren't withholding them from your paycheck.

Personal Financial Planning Process

The personal financial planning process is not a complicated one. However, it is an essential one and something you should turn into a habit.

By considering, determining, and journalizing your income inflows and expenditure outflows in detail, you will be in a much stronger position than most people because you will know exactly where your personal finances sit, where you can and cannot cut corners, and which direction your personal finance is trending (i.e., upwards or downwards) and act accordingly.

Since you're in high school, this is the perfect time to start this process and turn it into a regular practice. Since your personal finances are relatively simple right now, it will be easy to start.

By scrutinizing, identifying, and writing down your income, savings and investments, checking account amounts, budget, credit usage and credit scores, insurance costs, and expected income taxes, you will be in control of your personal finance and have the information necessary to act accordingly.

Importance of Personal Finance

The importance of personal finance cannot be overstated, and it is a subject all young people should learn about.

When you take the time to understand the elements that determine your personal finance, it puts you in a position of control and direction. With this information, you can proactively forge a positive future financial wealth trajectory, just like the most successful and wealthy people in the world.

There's no time like the present. Start now and begin understanding, quantifying, and predicting your income, savings and investments, checking account amounts, budget, credit usage and credit scores, insurance costs, and expected income taxes.

Be bold and plan your personal finance for the next 10 years and see what it might look like.

The rest is up to you. Now that you have the information and the direction, all you have to do is execute, and hopefully, you'll never feel broke again.