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Personal Finance Economics

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!

Personal Finance Economics No Money Pixabay StudySmarterFeeling 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.

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.

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.

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.

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.

Liquidity describes the ease with which an asset can be exchanged for cash. As a result, cash is the most liquid of assets. The easier it is to convert an asset into cash, the more liquid it is.

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.

Life insurance is similar to the types mentioned above, with the exception that it is meant to financially protect your loved ones when you pass away. Unlike life insurance, you may never need to use your car, home, or health insurance, but you will still have to pay the premiums whether you use them or not.

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.

Why do taxes exist?

In most developed countries, local, state, and federal governments take on the responsibility of providing goods and services to their constituents because they don't believe the private market could, or would do so.

Examples of these types of goods and services include military spending, retirement security, disaster recovery, schools, fire and police protection, and highways and other infrastructure requirements.

As a result, in order to pay for these goods and services, governments make individuals and businesses pay taxes, which go toward creating a government budget where the specific items and amounts for these expenditures are determined.

How should you think about taxes?

Let's say you do chores around the house, and that by doing so you generally earn $100 per month. If this is the case, the first thing you should be aware of is that the money your parents paid you for that work is after-tax money. In other words, your parents already paid taxes and other deductions on the money they paid you.

This is important because:

  1. You don't have to pay income taxes on these earnings unless you make more than the minimum income threshold for your tax bracket.
  2. The money you received actually came from a larger pre-tax and pre-deduction amount.

Hypothetically, let's say you live in a place where income earners pay 30% of their earnings to income taxes and other deductions. That means that for every dollar your parents gave you meant they actually had to earn $1.42. That also means that the dollar you earned can also be thought of as an income of $1.42 in pre-tax, pre-deduction terms.

This is a critical thing to remember. Every dollar you spend should be thought of in pre-tax, pre-deduction terms. Every time you go to spend money, ask yourself: How much in pre-tax, pre-deduction earnings does this represent?

In some places, people pay as much as 50% of their earnings to taxes, insurance, retirement plans, and more. In this scenario, every dollar you spend requires $2 in actual earnings. In other words, you have to earn $2 just to be able to spend $1!

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:

Inflow/Outflow ItemInflow/Outflow TypeInflow/Outflow Amount
IncomeRegular Recurring+$100
Savings DepositRegular Recurring-$20
School LunchRegular Recurring-$20
Cell PhoneRegular Recurring-$15
Dinner with FriendsUnpredicted-$18
Online Product PurchaseUnpredicted-$23
Car PaymentRegular Recurringn/a
Health, Life, and Home InsuranceRegular Recurringn/a
UtilitiesRegular Recurringn/a
End of Week Net Position
+$4

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.

Inflow/Outflow ItemInflow/Outflow TypeInflow/Outflow Amount
Chequing AccountUnpredicted+$4
IncomeRegular Recurring+$100
Savings DepositRegular Recurring-$20
School LunchRegular Recurring-$20
Cell PhoneRegular Recurring-$15
Dinner With FriendsUnpredicted-$18
Online Product PurchaseUnpredicted$0
Mom Birthday GiftUnpredicted-$25
Car PaymentRegular Recurringn/a
Health, Life, Home InsuranceRegular Recurringn/a
UtilitiesRegular Recurringn/a
End of Week Net Position $6

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.

Personal Finance Economics - Key takeaways

  • Personal finance is both a snapshot of your current financial state, as well as a mindset of how to best manage your financial state into the future.
  • Key components of personal finance include:
    • Income
    • Savings and Investments
    • Checking accounts
    • Budgeting
    • Credit and Credit Scores
    • Insurance
    • Taxes
  • When you take the time to understand the elements that determine your personal finance, it allows you to proactively forge a positive future financial wealth trajectory.

Frequently Asked Questions about Personal Finance Economics

Personal finance is both a snapshot of your financial state, as well as a mindset of how to best manage your money and other financial tools.

Yes, personal finance is a part of economics. The way individuals behave regarding their personal finance is a small but key piece of the overall economic landscape.

The 5 main components of personal finance are:

  • Income
  • Spending
  • Savings
  • Investing
  • Insurance

An economist would argue that personal finance is a key component of economics. In fact, the underlying assumptions associated with personal finance economics and rational behavior are the same ones used to explain and understand the behaviours of businesses and governments.

Some of the key components of personal finance include:

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

Final Personal Finance Economics Quiz

Question

What is credit?

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Answer

Credit is primarily a link formed between a lender and a borrower where the borrower agrees to pay the lender back (usually with interest).

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Define terms of credit

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Answer

Terms of credit is a deal between a supplier and consumer that specifies the schedule and quantity of prospective payments that the customer will make.

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What are the four parts to the terms of credit?

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Answer

The interest rate, collateral, documentation, repayment method

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What are the three types of credit?

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Installment, revolving, and open

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What's installment credit?

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Answer

Installment credits are credits that have a set payment plan for a certain period of time.

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What's revolving credit?

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Answer

Revolving credit is a sort of credit that has a limited amount and can be utilized up until the specified limit is met.


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Define open credit

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Answer

Open credit is credit that needs payment in full for every period, like every month. 

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Question

Name at least two sources of credit.

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Answer

Commercial banks, financial institutions, credit cards, public deposits, trade credit

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Question

When you add assets to a record, the difference is a debit since something has to be paid for that addition. 

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Answer

True

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Question

An increase in debt is a ______ since it represents money borrowed from someone else and utilized to buy goods or services.

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Answer

credit

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Question

Credit isn't free money; it's just ________ money


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Answer

borrowed

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Question

 A mortgage is an excellent illustration of a(n) _________ credit


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Answer

installment

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Question

What's the disadvantage of credit cards?

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The disadvantage is that it is among the most expensive types of loan if the borrower fails to meet the payment date.

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What's meant by the repayment method?

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Answer

It means that the manner in which the debtor will pay off the loan has to be specified. 

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________ ______  are the first source of credit people usually think of.

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Answer

Commercial banks

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Question

What is Human Capital in Economics?

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Answer

In Economics, human capital refers to the level of health, education, training, and skill of workers. 

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Why is human capital important?

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Because it is one of the primary determinants of the productivity (efficiency) of labor, which is one of the four factors of production.

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What happens when there is an increase in human capital?

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Any increase in human capital is considered to increase the supply of output that can be generated. 

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Explain how an increase in human capital increases the overall output.

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When you have more individuals working and having the necessary technical skills to produce certain goods and services, more output will be produced.

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What are 3 examples of human capital?

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A key example of human capital is workers' education level.

A second example involves job training programs.

A third example involves programs that support the health and welfare of workers.

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How an increase in the level of education affect human capital?

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Answer

Increased education increases productivity by improving workers' skills and ability to quickly learn and perform new tasks. 

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What's the difference with workers who are more literate and those who are not?

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Workers who are more literate (able to read and write) can likely learn new and complex jobs faster than those who are less literate.

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How can economies increase human capital?

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Economies can increase human capital by subsidizing (providing government funds for) increased education.

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How job training programs affect human capital?

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Similar to education, job training programs also improve worker skills. Government funding for job training programs can increase national output (gross domestic product, or GDP) by giving unemployed workers the skills necessary to gain employment. 

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What are the characteristics of human capital?

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Human capital includes education, qualifications, work experience, social skills, and communication skills of the labor force

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Is human capital the most important factor of production?


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Answer

Human capital is not the most important. However, it is one of the 4 factors of production.

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Explain education with regards to human capital.

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Answer

Education refers to a formal education provided by a K-12 school, community college, or four-year university. 

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Explain qualifications with regards to human capital.

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Qualifications include degrees and certifications, which are granted by various governing organizations. 

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Question

What does the Human Capital Theory state?

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Answer

The human capital theory states that improving education and training is a primary factor in increasing productivity.

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What should the government do to improve productivity according to the Human Capital theory?

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Answer

Improve education and provide training programs.

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Question

What is the definition of money management?

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The definition of money management revolves around an individual or group's ability to manage money efficiently so that it yields the highest return possible

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What are some examples of money management?

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Creating a budget, saving money, investing money, spending money, and simply keeping track of how a person or organization spends their capital are all examples of money management. 

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Why large companies play an important role in the US economy?

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Large companies that manage trillions of assets play an essential role in the U.S economy. This is because these companies ensure that proper and efficient investment takes place. They invest in startups or companies that have higher chances of delivering value to society and solving business problems that exist out there.

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What are some alternative terms for money management?

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Investment management and portfolio management.

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What does money management refer to in financial markets?

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In the context of the financial markets, the word is most often used to refer to an investment expert who makes choices on allocating vast pools of assets, such as those found in pension plans or mutual funds.

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What's the role of financial advisers?

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Answer

They assist with comprehensive plans for managing one's finances, which may include retirement planning, estate planning, and other topics.

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What are the types of money management?

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Answer

There are many types of money management; however, the main ones include Personal Finance, Corporate Finance, and Financial Markets. 


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Explain personal finance.

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Answer

Personal budgeting, spending, and saving are all aspects of money management in personal finance (investing). Proactive financial planning at periodic or ongoing intervals allows for better management of one's finances.

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Explain corporate finance.

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Corporate money management considers several factors, including the use of capital, raising capital (including how much capital should be raised and how it should be raised), and other factors. 

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Explain financial markets in the context of money management

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Answer

Money Management in Financial Markets is concerned with investment and portfolio management. That is, instead of simply ensuring that your savings and consumption are managed efficiently, such as in personal finance, financial markets money management seeks to make sure that clients receive a return on their money. 

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Question

What are some of the money management skills?

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Answer

Some crucial money management skills include: setting realistic financial goals, budgeting, contributing to savings.

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Explain how setting financial goals is a good money management skill.

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Answer

When people manage money, they often get greedy and set unique financial goals. This pushes them to invest in risky assets and makes them less cautious as they focus on meeting that high return on their investment. One should choose to invest in assets that have a good balance between the risk and the return you get.

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Explain how budgeting is a good money management skill.

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Answer

A good money manager should keep track of their expenses and income and aim to find a lifestyle that optimizes how the two are allocated. You should consider the portion of the income you want to consume and save so that you can keep growing wealth for the future, but not wholly reducing consumption now. 

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Explain how contributing to savings is a good money management skill.

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Answer

A good money manager should always find a way to contribute to saving efficiently. Perhaps you could open a savings account or invest in some stocks that you expect a high return from.

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Question

What are some of the money management strategies?

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Depending on the risk tolerance you or your client has, there are a variety of money management techniques one could use. You could be actively investing in one sector of the economy, such as the real estate market, or you could build up a portfolio of early-stage companies that you expect to grow. 

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What is insurance?

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Answer

Insurance is protection against any unexpected financial hardship or losses such as a car accident, fire, or medical bills.

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Question

What is an insurance policy?

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Answer

An insurance policy is a document that specifies what the insurance covers, how much the policyholder has to pay, and the circumstances under which the policy is valid.

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Question

What is a deductible?

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A deductible is the amount of money that has to be paid out of pocket before the insurance pays for the rest.

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Question

What is the difference between a deductible and a co-pay?

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Answer

A deductible must be paid before the insurance will begin to pay, while a co-pay if a flat free that you have to pay at the time of service. It is most common in healthcare.

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Question

What are the main features of insurance?

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Answer

Sharing or risk, indemnification, fortuitous loss, aleatory, and unilateral.

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