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Why is Personal Finance Knowledge Important? – Explained with examples

Everyone in this world keeps talking about personal finance. “You must know personal finance” or “learn personal finance” or starting personal financing and planning”, but what does it all mean?

Well, you need first to understand what is Personal Finance. It is not rocket science, nor it is something very complicated. It is effortless and easy to learn personal finance. Once you get the idea of it, it can help you in multiple ways.

There are a lot of benefits you get when you get your personal finances right. Let us discuss everything you must know about Personal Finance.

What is Personal Finance?

Personal Finance, as the name suggests, is related to your Finances personally. It refers to a process where-in; you systematically manage your earnings to grow your wealth over the years. It ensures that you are not wasting your money on things you do not need and by doing so, miss out on things you should be doing.

According to Investopedia,

Personal finance is a term that covers managing your money and saving and investing. It encompasses budgeting, banking, insurance, mortgages, investments, retirement planning, and tax and estate planning. It often refers to the entire industry that provides financial services to individuals and households and advises them about financial and investment opportunities.

But to begin with, you need not hire a Personal Finance Expert or Financial Advisor to manage your money.

Honestly, it depends on the money you make annually. If it is a huge number and you are unable to keep track of everything, it will be an excellent decision to hire a financial advisor. Where-as, if you are starting and want to hustle, you need to do it on your own personal.

Personal Finance can be very simple and easy at times and very complicated at the other. It can help you achieve your goals quickly, only if you are consistent.

It includes you making a budget for all of your expenditures; it must consist of everything. Every single place you spend money should be a part of your budget. For me, making a pie-chart helps a lot. It is straightforward to understand.

It is very IMPORTANT to SAVE

The most crucial part of personal finance and budgeting is saving money and investing. The concept behind saving money is that in-case there is an emergency, you should always have some reserve funds to meet those emergency expenses.

If you do not save money for emergencies, you might have to struggle to pay off the expenses that might occur in the future. For which, you might end up taking up debt.

Why is personal finance important?
Source – Internet

You should never use debt to finance your expenses, but to finance your assets and investments. When you use debt or borrow money to pay off your expenses, you then work hours to pay off that debt. And mostly these are the things which you can avoid.

In that case, why would you want some other debt on your head? A mortgage over a long term puts pressure on your brain and affects it as well.

When you save money, you can create a fund or a corpus. This corpus or fund can later be used to earn a passive income. How can my saving help me earn passive income? (I shall cover that in a separate article)

Why should I invest my Savings?

When you save money, for example, let us say, you have saved Rs. 1,00,000. Now, let us do some maths –

(The below scenario is for India)

If you choose to keep your money in a savings bank account, the bank will pay you an interest rate of 4-6% per annum (depends on your bank). So,

Rs. 1,00,000 X 5% = Rs. 5,000 per annum

But in-case, you choose to buy some mutual funds amounting to Rs. 1,00,000, you can earn a return of minimum 12% (on a three-year investment),

Rs. 1,00,000 X 12% = Rs. 12,000 per annum

The difference in the two scenarios is:

Rs. 12,000 – Rs. 5,000 = Rs. 7,000 per annum.

So, if you keep your money in your savings bank account, you will take 2.4 years to earn equivalent return, that you can earn in Mutual Funds in just one single year.

Let us now do a comparison for three years :

Savings Bank Account : Rs. 1,00,000 can earn you an interest of Rs. 16,075 in three years at an annual rate of 5% per annum

Mutual Funds : Rs. 1,00,000 can earn you an interest of Rs. 42,576 in three years at an annual rate of 12% per annum

Now, the difference in the two cases is,

Rs. 42,576 – Rs. 16,075 = Rs. 26,501

Rs. 26,501 is a very good amount, not a minute difference.

In the above case, I took the example of Mutual Funds, but there are various options available for investment.

By the above example, we can figure out one thing for sure, allowing your money to sit in a savings bank account is costly for you. So, please do not keep your savings in saving bank account.

But, when I say that you should not keep your savings in a bank account, I do not mean that you should invest all of your savings. There is a systematic method and way of investing. You need to ensure that you are liquid as well.

What does staying Liquid mean?

As the name suggests, you need to have some liquid funds. Liquid Funds include cash and bank balance, marketable securities and other instruments that can get converted into cash very quickly and easily.

Liquid funds help you reduce the risk of your portfolio and that is why is becomes very important to have them. Never do the mistake of investing all your savings. As the liquid funds, turn out to be your contingency fund or emergency fund. Helping you to pay off your un-for-seen expenses.

According to me, I would recommend you to keep 20-25% of your savings in liquid funds or liquid form. It equalises your risk and as liquid funds carry no or very low risk, it is must to have in your investment portfolio.

What should you do when you receive your pay check?

You need to get on to your computer and start pre-paring a budget. You need to take in-to account all the expenses for the month and saving. I would recommend you to just do this in Microsoft Excel itself.

The very first thing you need to do is, write down all your major expenses for the month – rent, EMIs, etc. – these are the important and necessary expenses.

Deduct them from your earnings. Now, you are left with other expenses and surplus. So, you should now, note down all the other expenses you need to make. This is the place where you need to test yourself. Because, you must reduce your expenses that are not required and other alternatives which are cheaper.

Personally, you should save 30% of your earning. Well, it will depend on the expenses that you have, you can definitely get in touch with me to get some help to prepare a budget and get your personal finances right.

If you follow a method and get systematic with your earnings, you will be able to save a lot of money in a short time frame.

The issue is that, we often just think that we do not have any extra money to save or we earn less. But the problem is not of earning less, it is of poor management. A good management of money can allow you to survive with a small amount as well.

Managing money is very important, this is because if we cannot manage small amount well, you will not be able to manage huge amount as well. We think that this is a small amount and does not require management. But that is totally wrong, management is management and the amount should not matter.

What are the different options for Investing your saving?

The financial markets are never-ending. There are numerous ways for you to invest your money. Many of these options are which many people are not even aware off.

                 

This is an interesting video by Phil Town. In the video, he explains how young people can invest in their 20’s to ensure that they are able to get a big enough retirement fund.

The key to investing is the time period. The more number of years you are invested, the more is your return. Because, when you invest for a long term period, you get the advantage of compounding.

And as Warren Buffet says, compounding is the seventh wonder of the world.

Well, the options for your investment depend on the country you live in. In this case, I will be taking example of India. If you are in India, what all are your options for investments.

Please note, there are general options for investing. You must wisely choose the best option for you.

  • Fixed Deposits – You must have heard about FDs, they carry a higher interest rate than savings bank account and lower than other marketable securities. But they are relatively safer option.
  • Equity Stocks – These are the owner-ship stocks in any company. You can invest in any company that is listed on any of the Stock Markets. They do not carry any interest rate, but provide you with wealth maximisation and dividends.
  • Private Investments – If any of your relatives or friends are starting a new business, you can invest some money and get owner-ship stake in their business.
  • Mutual Funds – These are the single unit funds issued by the Asset Management Companies, you give your money to the AMCs and they invest in different options on your behalf. You can choose from various mutual fund schemes – Equity, Debt, Hybrid, Long-Term, Liquid, Short-Term, Blue Chip, Nifty 50, Mid-cap, Small-cap, etc.
  • Treasury Bills – Reserve Bank of India issues marketable securities on behalf of the Government of India to raise funds and provide interest on the same. These are the most safest investment you can every make.
  • Sovereign Gold Bonds – Government of India issues gold bonds, which helps you to buy Gold (not in physical form) and gain interest on the investment as well as price appreciation.
  • Crypto-currencies – Crypto-currencies are the new trend and gaining acceptance all over the world. These are virtual currencies having no physical form.

How to manage money effectively?

The truth is, it is not very easy to manage money. I personally take money as a girl / lady. And you need to ensure that you give enough time and focus to her, or else, she will not be with you. Similarly, you need to give enough time to manage your money as well.

This will help you to be able to achieve your financial goals and achieve financial freedom. Everyone today, wants to be financially free. But it is not easy.

You need to save money from however small or big amount you earn. Until you make savings a part of your financial plan, you will not be able to manage money well.

Your personal finances are similar to a business. You need to ensure that your expenses are minimum and revenues are high. In this case, the revenues are our income and earnings, while the expenses still remain expenses.

When you minimum your expenses or look for an alternative to reduce your expenses, your profits are maximum. Similarly, when you reduce your expenses, you will be able to save more and hence, invest more. This is the path for wealth maximisation.

There will not be any miracle with help of which, you will learn to manage your money and earnings better. You need to start by making a budget and start saving.

It will take time to change your habits. There are small habits that we have and they drain our money without us even realising. Let us take an example of smoking.

If you smoke, let’s say, 10 cigarettes everyday. You are spending – Rs. 15 x 10 = Rs. 150 every day.

It will sum to, Rs. 150 x 30 = Rs. 4,500 per month.

Conclusion

You do not have to panic. The great thing is that you realised that you need to get your personal finances right and it is not too late to start now. You can get your habits corrected with-in two to three months and get back on track. Eventually, in the coming year, we can change a lot of your financial planning, budget and a lot more.

So, ensure that you have subscribed to my news-letter to never miss a single blog update. Together we can and we will grow financially.

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