One of the major reasons we fail to secure a financially stable life is because we are unaware of the things that we need to put in place to make it right. Having the basic personal financial skills is one of the most important things we can do to live a healthy and happy life. It is also important to know what the key areas of our personal finance is so that we can keep focus on while creating a road map for our financial well being.
Before deep delving into the topic, it is important to note that there are 5 areas of personal finance. There are saving, investing, financial protection, tax planning and retirement planning, but in no particular order.
What are the 5 areas of personal finance? The areas of personal finances are 5.
- Savings: You need to keep money aside as savings to cover any sudden financial need.
- Investing: Investing is important to grow money so that you can achieve what you aspire.
- Financial protection: Now, financial protection through insurance ensures you and your family are able to sail through during the hard times.
- Tax planning: With proper tax planning, i.e. making adequate expenditure/investment, you can bring down your taxable income, eventually saving a lot of money every year.
- Retirement planning: Finally, retirement planning is crucial to ensure that you have a big bank balance meant solely for your needs during the twilight years.
These are the important aspects of a complete financial picture and we will discuss each of the 5 areas in full further detail:
1. Savings:
The need for sudden money can come at anytime. That is why saving money is important for a number of reasons. Firstly, it helps you to manage your expenses and avoid overspending. By setting aside a certain amount of money each month, you can ensure that you have enough money to cover your basic needs, such as food, rent, and bills.
Secondly, personal savings can provide a safety net in case of emergencies. It is essential to have some money saved up for unexpected expenses, such as medical bills or car repairs. By having a savings account, you can avoid going into debt or relying on credit cards to cover such expenses. It also provides peace of mind and reduces financial stress.
Thirdly, savings can help you to achieve your long-term financial goals, such as buying a house, starting a business, or retiring comfortably. When you set aside money regularly, you can accumulate a significant amount over time and use it to achieve your goals.
However, such emergency events can be dealt with if we have enough savings to cover the need. As a thumb rule, the fund for your emergency needs should be three to six month of your expenses.
2. Investing:
The majority of people consider investment and savings to be synonymous. The point is they are different. Savings as we have earlier stated are excesses from your income after all expenses. While investment involves purchasing assets such as mutual funds, real estate, stocks, bonds, etc. with your money with the expectation to generate a rate of return. Investment comes with a lot of risks. This is because not all assets actually end up yielding ROI.
Now talking in terms of investment, mutual funds are an excellent investment option if it is done right. However, while investing in mutual funds it is essential to be mindful about choosing the right fund for your investment, otherwise it might turn counterproductive.
Now what funds should one pick as per their financial goals?
Short term goals: The goals that need to be achieved within three years are short term goals. From saving for a trip to saving for a phone, there are multiple things for which one needs to arrange funds within this timeframe.
Mid-term goals: If you have set a goal for yourself that needs to be achieved within three to five years, for example downpayment for a house, it can be termed as mid term goals.
Long term goals: Milestone events like retirement, children education, their marriage, i.e. the goals for which the timeframe is minimum of 5 years are termed as long term goals.
3. Financial protection: We might have different dreams in life and create investment plans to turn those dreams into reality. But unless we protect them with a safety net, the same can turn into a liability. That safety net is insurance. This is a wide array of products that you can use to guide against unforeseen occurrences. In the case of finances this is generally purchasing some type of insurance. Insurance is a means of protection from financial loss. It is a form of risk management, and it can be used to prevent the risk of a contingent or uncertain loss. There are 4 kinds of insurance we all need which I will discuss below.
The Consumer Financial Protection Bureau was created to provide some financial education assistance and financial tools to consumers that desire to have the facts about financial matters. For more information visit, www.cfpb.gov.
1. Term insurance
1. Term insurance
It is a kind of life insurance that ensures that your family or dependents do not have to go through financial hardship if you die early. As compared to other health insurance products, the sum assured for term insurance is higher as against the premium amount. Now if you calculate it correctly, then you can account for day-to-day expenses of your family, a retirement corpus for your spouse, cover for your liabilities like – home loan, and children’s education in the sum assured.
2. Health insurance and Critical Illness insurance
Having health insurance ensures that you do not have to pay from your pocket in case you or any of your family members have taken ill. Health insurance covers all costs for treatment of the insured like hospitalisation, medication, pre and post hospitalisation expenses etc. Meanwhile you can opt for critical insurance along with your basic health policy. In case you are diagnosed with one of the critical illnesses mentioned in your policy, the insurance company will pay you the sum assured.
3. Mortgage Protection insurance
Mortgage protection insurance pays off your mortgage if you die during the term of the mortgage. It ensures the loan or mortgage for home, car, property etc. does not become a liability for your family, in case you die early.
4. Personal Accidental insurance
In case you meet with an accident and get seriously injured, or become partially or fully injured, the insurance company will pay the sum assured to cover the expenses for treatment and also loss of income. Meanwhile, if you die during the accident, the lumpsum amount will be paid to your family. The payable amount, however, is dependent on the fatality of the accident.
Having financial goals is very important to provide you and your family with financial freedom and security. The earlier you start having a financial plan, the better.
5. Retirement planning
Retirement is one of the most crucial stages our life, and it can be as blissful or as miserable depending upon how we have planned for it. It holds true for financial planning too.
There are two aspect to consider when planning for retirement. First, is saving for retirement and second is, generating income from your assets during retirement. And, here are the two steps:–
1. Building a retirement corpus: Saving for retirement is crucial for two reasons majorly – loss of income and increased life expectancy. Let’s assume that you retire at 60 and live up to 85. How do you plan to fund your expenses for 25 years after retirement, at a time when you do not have any steady income?
Plus, considering inflation, i.e. the rise in prices of goods and services for regular use, your expenses will be much higher after retirement than it is today. For example, if your monthly expenses are Rs 35,000 right now, it would be Rs 80,000 per month in 20 years, considering you would want to maintain similar living standards.
Now, building a fund as large as a retirement corpus is a lifelong process. So, the earlier you start saving, the better it is.
2. Generating income during retirement: As much as it is important to ensure that you are saving enough for your retirement while you are working, it is equally important that you channel that corpus correctly after retirement. Making the right investments will ensure that you have a steady income as long as you live.
Investment options for generating income during retirement: STP withdrawal/transfer from Mutual Funds, life insurance annuity, and rental income.
Saving money is an important part of personal finance and can provide financial stability and independence. According to a rule of thumb, don’t spend more than you earn. The instant this starts happening, debt is imminent. Although going into debt can be very helpful. But this is when you borrow to secure an asset with the expectation of a return.
The process by which you manages your personal finances is usually summarized in your financial plan or a budget. Having all the aspects of a complete financial picture in one frame ensures that your financial future is just picture-perfect.
