There are different approaches to saving money. Whether it's saving for a short term goal or saving for your retirement, people go about it in a variety of ways.
I admire those who have a set amount which they put aside each week (or each month) before they spend any money. I call these people conscious savers. It's a regular savings plan. The money is normally deducted from their pay or taken out of their bank account at the beginning of each period.
This sort of approach works for these people because there is a risk that if the money is not put aside immediately, it will get spent. It's a smart move and it lends itself to better long term planning, whether that planning relates to reducing debt or investing for the future or saving to buy a house or whatever.
Unfortunately, I'm not that disciplined. In fact my approach is the exact opposite. I tend to pay all of the bills and spend what I need to each month and only at the end of each month does what's left over get added to our savings.
Fortunately, that works for us. We don't have extravagant tastes and lead a fairly middle of the road existence and our income has always been such that we've been able to add enough to our savings each month to pay off all of our debts, including our mortgage and accumulate a reasonable investment portfolio that will someday become the foundation of our financial freedom.
Despite our success in the past at just following a saving what's left over approach, I do wonder whether a more conscious approach would put us further ahead over the long term. Maybe the extra financial discipline would enable us to save that little bit extra and help us reach our financial goals earlier.
The downside, as I see it, is that we may feel more constrained at living this way. There may also be more stress on our relationship if we attempt a more rigid approach to our personal finances.
What is the definition of personal finance?
Personal finance is a remarkably broad subject. The simplest way to define personal finance might be to take a look at each of the topics which come under the personal finance umbrella.
Record Keeping.
One of the fundamentals of personal finance is record keeping. It provides the foundation for everything else to build on. Keeping records means keeping track of all of your financial transactions. This includes what you earn, what you spend, what and where your savings (if any) are, insurance, and the list goes on. Record keeping can be as simple or as complex as you like. Some people will be thrive on tracking every individual cent that gets earned, saved and spent on a daily basis. Others will find this way too much overhead and will instead record approximate figures on a weekly or even monthly basis. Most people will find a working solution somewhere between these two extremes.
However you decide to do it, the main thing is to keep at it. Record keeping will enable you to understand what your financial position is now and how you've progressed over time. It will also provide valuable input into the planning process.
Budgeting.
Budgeting could be considered the counterpart of record keeping. The two go arm in arm. Budgeting is the practice of estimating future income and expenditure. To create a budget you would normally offset your expenses against your income month by month for the next year (and beyond). That way you can see what the surplus or shortfall is each month. This can help with planning your investments or by identifying where your future cash flow problems might lie.
Financial Position.
Another key area of personal finance is your financial position. Knowing this is key. When used in conjunction with your record keeping and budgeting, your statement of financial position is a key tool in meeting your financial goals. In it's simplest form, it's a document which lists your assets and your liabilities and which will hopefully show a surplus on the asset side. Even if it doesn't show a surplus of assets, it will provide you with a starting point on your road to freedom from debt.
Credit and other forms of Personal Debt.
And speaking of debt, this is another broad topic within personal finance. Not many of us can go through life without resorting to some sort of debt. Whether it's a mortgage to fund the purchase of a house, a personal loan to buy the car of our dreams or credit card debt to be used for day to day living and the odd larger consumer purchase, most of us will be in debt at some time or other.
But there are different types of debt. Borrowing money to finance investments can be a powerful wealth generating tool. However payday loans and other forms of cash advance are normally to be avoided if at all possible.
Saving and Investing.
Saving money is something we should all aspire to. It could be saving enough money to put aside in an emergency fund to provide a financial buffer in unforeseen circumstances. Or it might be saving for the kids' education or maybe even an overseas trip. And saving ties in nicely with budgeting. Saving is what we can do what the money which our budget tells us should be left over each month.
Then once you've accumulated some savings, you may look at how to invest them. Investing is a complex area with many complex investment products available. You might buy shares, real estate or a mutual fund. You can even invest in non-financial asset like art or wine providing you know what you are doing. Investing is how you take your accumulated saving and put them to best use to grow your wealth over the long term.
Insurance.
What does insurance have to do with personal finance? Well, what's the point in doing all of that hard work to get your personal finances in order just to see some catastrophic event wipe it all out? That's why insurance is such an important part of personal finance. Whether it's your house, your car, your income, your health or even your life, you need to make sure you have enough insurance for the worst case scenario.
Tax.
Nobody likes paying tax, but with some careful planning and good advice, you can at least minimize the amount of tax you need to pay. I'm sure most people would agree that we pay more than enough tax already. And by organizing our personal finances better, we may be able to reduce our taxes freeing up more money to save and invest.
Retirement Planning.
For some people this is what it's all about. You need to make sure that nest egg has grown large enough to support you once you stop paid employment. By putting the right strategies in place earlier in life you can help ensure you have a comfortable retirement.
Mastering each of the above topics should put you well on the way to living large in retirement.
Estate Planning.
They say that death and taxes are the two certainties in life. While nobody likes to think about their own mortality, it's important to consider your estate. How should it be distributed? Do you have any special wishes? Is your will up to date? A little planning and forethought may at least remove some of the financial worries from this difficult time.
I think the topics above cover this broad subject area reasonably well. In future posts, I will refer back to this "What Is Personal Finance" post often as I drill down on each of these topics.