Managing personal finances can be challenging, if only because the subject has so many facets to consider. More than just how much money you are spending and what you are using it to buy, personal finance includes the whole of an individual or household’s beliefs about money, financial goals, saving and investing practices and overall cash flow.
Thinking about and managing personal finances effectively means accounting for and making good choices about:
How individuals or households handle each of these facets has a direct and powerful impact on their overall personal financial health in both the long and short terms. To complicate matters further, none of these components of personal finance exists in a vacuum, as they are all interrelated. Changing one can alter some or all of the others, creating a fluid and constantly shifting fiscal landscape.
When households or families have a strong grasp of their personal financial goals and realities, this fluidity and interconnectedness can work to their benefits. Small changes made at the right times can reap outsized benefits. Fortunately, reaching this state of personal finance mastery is something anyone can do by practicing the basics of strong personal finance management.
Making a Plan
Understanding one’s personal priorities and setting ambitious but realistic financial goals are the hidden secrets to personal financial success. Only when a household has determined where its priorities lie can the household make informed choices about what to spend, what to invest and how. Counterintuitive as it may seem, then, the first step in the personal finance management process is for an individual to ask what he or she want his or her finances to do, and when.
For example, individuals struggling with heavy student loans may determine that paying down debt is their immediate highest priority. Families saving up to purchase a house or a new vehicle will need to work their finances in an entirely different approach. Investors most worried about long-term goals like college funds for their children or retirement will allocate their finances differently still.
Once a family has established their goals, they are almost ready to weigh their current choices and put their fingers on opportunities and problem areas ripe for change. Before they can do that, though, they need to make sure they have a clear view of their monthly (or yearly) cash flow.
Understanding and Managing Cash Flow
Understanding the flow of cash and other forms of income into and then out of a household is foundational to all other aspects of personal finance. Even the best budgets and financial plans will not last or work the way they are intended if they do not line up with the actual movement of money through a household. Although families can assess their cash flows over any period of time, monthly and yearly assessments tend to offer the most insight.
Understanding cash flow starts with income, in every form. Individuals should list everything they bring in over the month, including their salaries or wages, interest on bank accounts or other types of investments, benefits or assistance payments they receive from any source and the proceeds from any personal or household items they sell.
One the other end of the assessment, individuals should put equal diligence into tracking their expenses. It is essential that individuals or households exploring their cash flows pay attention to and record real, accurate numbers on their assessments. Estimates are notoriously faulty and can quickly derail the process or result in individuals needing to redo the process from scratch when the errors and inconsistencies become apparent down the line.
With a completed cash flow assessment in hand, households can expect to have a sharp view of numerous key elements of their personal financial health. This includes:
- The total ratio of income to expenses.
- Actual expenditures by time of month and category.
- The alignment (or lack thereof) between their stated personal and financial goals and priorities and where their money is allocated.
- Where money can be easily rerouted from one area to a more preferable or rewarding one.
Cash flow assessments can help families identify key weaknesses in their personal finances and are an excellent starting point from which to write or revise a budget. They also serve as a crucial starting point for anyone hoping to launch, build or restructure their larger financial portfolios.
Financial Portfolio Management
The phrase “financial portfolio” sounds complicated, but it is simply a concise way of referencing the full scope of an individual or family’s investments. A portfolio might be comprised on any combination of stocks, bonds, trusts and mutual or exchange-traded funds. Investors with larger sums in play may also have crowd funding or Angel Investing investments. It is increasingly common for personal financial portfolios to include non-traditional holdings and investments, such as cryptocurrency, as well.
Strategies for portfolio management are diverse. Despite the vast variety involved, most can be categorized as either passive or active strategies. Passive strategies rely primarily on identifying acceptable and relatively safe investments, allocating money to them and then leaving them to mature over time. Such investments tend to be reliable but offer relatively low returns.
Alternately, investors can select to manage their portfolios actively. Active management involves significantly more research and the regular shifting and reallocating of assets. Typically, higher levels of risk and higher rates of reward are involved. These two categories are not mutually exclusive, however. Investors can, and often do, choose to mix and match the types of investments they participate in and the risk levels associated with those opportunities. This mixing and matching maximizes investors’ chances of reaching their financial goals while insulating them somewhat from the negative effects of unpredictable market downturns.
One of the most overlooked but critical aspect of personal finance is timing. How long an investor has to reach his or her goals directly influences his or her need to participate in higher-risk/higher-reward investment tools. It also strongly dictates the amount of money an investor needs to funnel into investment tools each month. The longer an investor has to reach their goals, the more room they have to rely on lower-risk, longer-term investments and the less money they need to invest each month to ensure they will reach their goals. As a result, there is no substitute for beginning to invest as early in life as possible. The sooner individuals and households master their personal finances, the easier it becomes to manage and maximize the potential of their long-term portfolios.