Personal finance

From Wikipedia, the free encyclopedia

Personal finance is the financial management that an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events.

When planning personal finances, the individual would take into account the suitability of various banking products (checking accounts, savings accounts, credit cards, and loans), insurance products (health insurance, disability insurance, life insurance, etc.), and investment products (bonds, stocks, derivatives, etc.), as well as participation in and monitoring of income tax management and pensions.


Before a specialty in personal finance was developed, various disciplines which are closely related to it, such as family economics, and consumer economics, were taught in various colleges as part of home economics for over 100 years.[1]

The earliest known research in personal finance was done in 1920 by Hazel Kyrk. Her dissertation at University of Chicago laid the foundation of consumer economics and family economics.[1] Margaret Reid, a professor of Home Economics at the same university, is recognized as one of the pioneers in the study of consumer behavior and Household behavior.[1][2]

In 1947, Herbert A. Simon, a Nobel laureate, suggested that a decision-maker did not always make the best financial decision because of limited educational resources and personal inclinations.[1] In 2009, Dan Ariely suggested the 2008 financial crisis showed that human beings do not always make rational financial decisions, and the market is not necessarily automated and corrective of any imbalances in the economy.[1][3]

Research into personal finance is based on several theories, such as social exchange theory and andragogy (adult learning theory). Professional bodies such as American Association of Family and Consumer Sciences and the American Council on Consumer Interests started to play an important role in developing this field from the 1950s to the 1970s. The establishment of the Association for Financial Counseling and Planning Education (AFCPE) in 1984 at Iowa State University and the Academy of Financial Services (AFS) in 1985 marked an important milestone in personal finance history. Attendances of the two societies mainly come from faculty and graduates from business and home economics colleges. AFCPE started to offered several certifications for professionals in this field, such as Accredited Financial Counselor (AFC) and Certified Housing Counselor (CHC). Meanwhile, AFS cooperates with Certified Financial Planner (CFP Board).[1]

Before 1990, the study of personal finance received little attention from mainstream economists and business faculties. However, several American universities such as Brigham Young University, Iowa State University, and San Francisco State University started to offer financial educational programs in both undergraduate and graduate programs since the 1990s. These institutions published several works in journals such as The Journal of Financial Counseling and Planning and the Journal of Personal Finance.

As the concerns about consumers' financial capability increased during the early 2000s, various education programs emerged, catering to a broad audience or a specific group of people, such as youth and women. The educational programs are frequently known as "financial literacy". However, there was no standardized curriculum for personal finance education until after the 2008 financial crisis. The United States President's Advisory Council on Financial Capability was set up in 2008 to encourage financial literacy among the American people. It also stressed the importance of developing a standard in financial education.[1]

Personal finance principles[edit]

Individual situations vary significantly when it comes to income, wealth, and consumption requirements. Moreover, tax and financial regulations vary between countries, and market conditions change both geographically and over time. This means that advice for one person might not be appropriate for another. A financial advisor can offer personalized advice in complicated situations and for high-wealth individuals. Still, University of Chicago professor Harold Pollack and personal finance writer Helaine Olen argue that in the United States, good personal finance advice boils down to a few simple points:[4]

  • Pay off credit card balances every month in full
  • Save 20% of income
  • Create an emergency fund that can last at least 6 months
  • Maximize contributions to tax-advantaged funds such as a 401(k) retirement funds, individual retirement accounts, and 529 education savings plans
  • When investing savings:
    • Avoid trading individual securities
    • Look for low-cost, diversified mutual funds that balance risk vs. reward appropriately to an individual's target retirement year
  • If using a financial advisor, require them to commit to a fiduciary duty to act in an individual's best interest

Personal financial planning process[edit]

The key component of personal finance is financial planning, a dynamic process requiring regular monitoring and re-evaluation. In general, it involves five steps:[5][6]

  1. Assessment: A person's financial situation is assessed by compiling simplified versions of financial statements, including balance sheets and income statements. A personal balance sheet lists the values of personal assets (e.g., car, house, clothes, stocks, bank account, cryptocurrencies), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statement lists personal income and expenses.
  2. Goal setting: Multiple goals are expected, including short- and long-term goals. For example, a long-term goal would be to "retire at age 65 with a personal net worth of $1,000,000", while a short-term goal would be to "save up for a new computer in the next month." Setting financial goals helps to direct financial planning. Goal setting is done to meet specific financial requirements.
  3. Plan creation: The financial plan details how to accomplish the goals. It could include, for example, reducing unnecessary expenses, increasing employment income, or investing in the stock market.
  4. Execution: Execution of a financial plan often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
  5. Monitoring and reassessment: The financial plan is monitored for possible adjustments or reassessments as time passes.

Typical goals that most adults and young adults have are paying off credit card/student loan/housing/car loan debt, investing for retirement, investing for college costs for children, and paying medical expenses.[7]

Need for Personal Finance

There is a great need for people to understand and take control of their finances. These are some of the overarching reasons for it;

1. No formal education for personal finance[8]: Most countries have a formal education across most disciplines or areas of study.

  • Their pursuit translates to earning tangible outcomes in the form of money.
  • Even when we realize the above to be a primary objective, there is no formal education at an elementary level in schools or colleges to learn money management or personal finance.
  • Hence, it is essential to understand this gap or disconnect in the education system where there is no formal way of equipping individuals to manage their own money.
  • In 2023, more than half of US high school students will be required to take a personal finance class before graduation.[9]

This illustrates the need to learn personal finance from an early stage,[10] to differentiate between needs vs. wants[11] and plan accordingly.

2. Shortened employable age: Over the years, with the advent of automation [12] and changing needs; it has been witnessed across the globe that several jobs that require manual intervention or that are mechanical are increasingly becoming redundant.

  • Several employment opportunities are shifting from countries with higher labor costs to countries with lower labor[13] costs keeping margins low for companies.
  • In economies with a considerably large younger population entering the workforce who are more equipped with the latest technologies, several employees in the middle management[14] who have not up-skilled are easily replaceable with new and fresh talent that is cheaper and more valuable to the organizations.
  • Cyclical nature of several industries[15] like automobile, chemicals, construction; consumption and demand is driven by the health of the countries economy. It has been observed that when economies stagnate, are in recession, and in war - specific industries suffer more than others. This results in companies rationalizing their workforce. An individual can lose their job quickly and remain unemployed for a considerable time. All these reasons bring to the realization that the legal employable age of 60 is slowly and gradually becoming shorter.

These are some of the reasons why individuals should start planning for their retirement and systematically build on their retirement corpus,[16] hence the need for personal finance.

3. Increased life expectancy:[17] With the developments in healthcare, people today live till a much older age than their forefathers. The average life expectancy has changed, and people, even in developing economies, live much longer. The average life expectancy has gradually shifted from 60 to 81[17] and upwards. Increased life expectancy coupled with a shorter employable age reinforces the need for a large enough retirement corpus and the importance of personal finance.

4. Rising medical expenses:[18] Medical expenses including cost of prescription medicine, hospital admission care and charges, nursing care, specialized care, geriatric care have all seen an exponential rise over the years. Many of these medical expenses are not covered through insurance policies that might either be private/individual insurance coverage or through federal or national insurance coverage.

  • In developed markets like the US,[19] insurance coverage is provided by either the employers, private insurers or through federal government (Medicare, primarily for senior citizens or Medicaid, primarily for individuals of lower income levels). However, with the rising US fiscal deficit and large proportion of the senior population, it needs to be seen whether the extent of the Medicare program is sustainable in the long run, therapy exclusions in the coverage, co-pay, deductibles - several cost elements are to be borne by individuals continually.
  • In other developed markets like the EU, most medical care is nationally reimbursed. This leads to the national healthcare budgets being very tightly controlled. Many newer, expensive therapies are frequently excluded from national formularies. This means that patients may not have access through the government policy and would have to pay out of pocket to avail of these medicines
  • In developing countries like India, China, most of the expenses are out of pocket[20] as there is no overarching government social security system covering medical expenses.

These reasons illustrate the need to have medical, accidental, critical illness, life coverage insurance for oneself and one's family as well as the need for emergency corpus;[21] translating the immense need for personal finance.

Areas of focus[edit]

Critical areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:[22]

  1. Financial position: is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all household liabilities, at one point. Household cash flow totals all the expected income sources within a year minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and when the personal goals can be accomplished.
  2. Adequate protection: or insurance, the analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health, and long-term care. Some wagers may be self-insurable, while most require an insurance contract. Determining how much insurance to get, at the most cost-effective terms, requires knowledge of the market for personal insurance. Business owners, professionals, athletes, and entertainers need specialized insurance professionals to protect themselves adequately. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be critical to the overall investment planning.
  3. Tax planning: typically, the income tax is the single largest expense in a household. Managing taxes is not a question of whether or not taxes will be paid but when and how much. The government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax. As one's income grows, a higher marginal rate of tax must be paid. Understanding how to take advantage of the myriad tax breaks when planning one's finances can significantly impact.
  4. Investment and accumulation goals: planning how to accumulate enough money for large purchases and life events is what most people consider financial planning. Significant reasons to get assets include purchasing a house or car, starting a business, paying for education expenses, and saving for retirement.
    Achieving these goals requires projecting their costs and when to withdraw funds. A significant risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in various investments. To overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to several risks. Managing these portfolio risks is often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation for stocks, bonds, cash, and alternative investments. The budget should also consider every investor's risk profile since risk attitudes vary from person to person.
    Depreciating Assets- One thing to consider with personal finance and net worth goals is depreciating assets. A depreciating asset is an asset that loses value over time or with use. A few examples would be the vehicle a person owns, boats, and capitalizes expenses. They add value to a person's life, but unlike other assets, they do not make money and should be a class of their own. In the business world, these are depreciated over time for tax and bookkeeping purposes because their useful life runs out. This is known as accumulated depreciation, and the asset will eventually need to be replaced.
  5. Retirement planning is understanding how much it costs to live at retirement and developing a plan to distribute assets to meet any income shortfall. Methods for retirement plans include taking advantage of government-allowed structures to manage tax liability, including individual (IRA) structures or employer-sponsored retirement plans.
  6. Estate planning involves planning to disposition one's assets after death. Typically, a tax is due to the state or federal government when one dies. Avoiding these taxes means more of one's assets will be distributed to their heirs. One can leave their assets to family, friends, or charitable groups.
  7. Delayed gratification: Delayed gratification, or deferred gratification, is the ability to resist the temptation for an immediate reward and wait for a later reward. This is thought to be an important consideration in the creation of personal wealth.
  8. Cash Management: It is the soul of financial planning, whether a person is an employee or planning for retirement. It is a must for every financial planner to know how much they spend before their retirement so that they can save a significant amount. This analysis is a wake-up call as many of us know our income, but very few track their expenses.
  9. Revisiting Written Financial Plan Regularly: Make monitoring a financial plan regularly a habit. An annual financial planning review with a professional keeps people well-positioned and informed about the required changes, if any, in personal needs or life circumstances. It would be best to be prepared for all the sudden curve balls life throws.
  10. Education Planning: With the growing interest in students' loans, having a proper financial plan in place is crucial. Parents often want to save for their kids but make the wrong decisions, adversely affecting the savings. We often observe that many parents give their kids expensive gifts or unintentionally endanger the opportunity to obtain the much-needed grant. Instead, one should make their kids prepare for the future and support them financially in their education.
  11. Real Estate Planning: Shelter is a basic human need, and as such, it is imperative that one understands how to obtain a place to live and at the same time maintain their financial security. Housing can be very complicated, with decisions regarding buying or renting, mortgages, insurance, taxes, utilities, maintenance, etc. Apartment or house? That question is crucial for any individual as each option has pros and cons.
    Buy or Rent: If a person chooses to buy a house, they can make a financial investment in a home and improve their credit score and history. Home ownership can make life more stable. The price of the house, including the down payment, monthly mortgage payment, repair and maintenance costs, HOA fees, utilities, insurance, property taxes, and other costs, are considerations. If renting a home is chosen, there is no need to worry about maintenance and no real estate taxes. Moving to a different location can also be easier. Expenses for renters may include electricity, water, internet, parking, and pet fees.
    Mortgages: When purchasing a home/real estate, it is essential to understand the options. Most people either go with a 15- or 30-year plan. The payment rate can be a fixed plan, a constant payment of the same amount over a certain period. The other is an ARM mortgage (Adjustable-Rate Mortgage). This rate can be adjusted and agreed upon to be changed in the given plan depending on mortgage rate fluctuations. Mortgage plans depend on a person's situation, and it is essential for potential borrowers to assess their credit score and financial status when contemplating plans.
    Location / Wants and Needs: When choosing a new home, it is essential to consider the location, along with the qualities that are desired and needed in a home. These variables can increase or decrease the price of an estate. Location-related considerations include a city or rural location, length of commute, the importance of quality public schools, level of safety, the amount of land, included amenities, proximity to family. Examples of variables that would affect the value of an estate include but are not limited to, the quality of school systems in that area, proximity to the community, shopping and entertainment/recreation, safety levels and crime rates of the neighborhood, amenities, and land size and surrounding developments. It is essential to keep all of this in mind when thinking about the future value of a home.

Education and tools[edit]

An example of personal budget planning software

According to a survey done by Harris Interactive, 99% of the adults agreed that personal finance should be taught in schools.[23] Financial authorities and the American federal government had offered free educational materials online to the public. However, a Bank of America poll found that 42% of adults were discouraged. In comparison, 28% of adults thought that personal finance is difficult because of the vast amount of online information. As of 2015, 17 out of 50 states in the United States require high school students to study personal finance before graduation.[24][25] The effectiveness of financial education on general audience is controversial. For example, a study by Bell, Gorin, and Hogarth (2009) stated that financial education graduates were more likely to use a formal spending plan. Financially educated high school students are more likely to have a savings account with regular savings, fewer overdrafts, and more likely to pay off their credit card balances. However, another study done by Cole and Shastry (Harvard Business School, 2009) found that there were no differences in saving behaviors of people in American states with financial literacy mandate enforced and the states without a literacy mandate.[1]

Kiplinger publishes magazines on personal finance.[26]

See also[edit]


  1. ^ a b c d e f g h Tahira, K. Hira (1 December 2009). "Personal finance: Past, present, and future". Social Science Research Network. Iowa State University - Department of Human Development and Family Studies: 4–16. SSRN 1522299.
  2. ^ "Guide to the Margaret G. Reid Papers 1904–1990". The University of Chicago Library. 2010. Archived from the original on 3 July 2013. Retrieved 28 September 2015.
  3. ^ Ariely, Dan (July 2009). "The End of Rational Economics". Harvard Business Review. Archived from the original on 10 November 2022. Retrieved 28 September 2015.
  4. ^ "Can The Best Financial Tips Fit On An Index Card?". NPR. Archived from the original on 8 October 2020. Retrieved 5 April 2018.
  5. ^ "What is Personal Finance?". Maxprog - Stan Busk. Archived from the original on 13 March 2023. Retrieved 18 July 2022.
  6. ^ "Creating a Personal Financial Plan" (PDF). Missouri State University. Archived from the original (PDF) on 17 September 2015. Retrieved 28 September 2015.
  7. ^ "Goals:Setting financial goals". CNN. 28 May 2015. Archived from the original on 28 September 2015. Retrieved 28 September 2015.
  8. ^ "The Importance of Financial Education" (PDF). Archived (PDF) from the original on 11 January 2020. Retrieved 9 February 2020.
  9. ^ "More than half of U.S. high school students will take a personal finance class before graduation, following the passage of a new Pennsylvania law". 16 December 2023. Retrieved 23 December 2023.
  10. ^ Hayes, Deacon (7 November 2017). How to retire early: everything you need to achieve financial independence when you want it. Simon and Schuster. ISBN 978-1-4405-9989-7. OCLC 995023134.
  11. ^ Dierksmeier, Claus (2013), "Wants vs. Needs", Humanistic Marketing, Palgrave Macmillan, doi:10.1057/9781137353290.0010, ISBN 978-1-137-35329-0
  12. ^ "Figure 1.1. Risk of job loss due to automation" (xlsx). OECD. doi:10.1787/888933500622.
  13. ^ Berger, Suzanne. (2006). How we compete: what companies around the world are doing to make it in today's global economy. Currency Doubleday. ISBN 0-385-51359-3. OCLC 62734878.
  14. ^ "The Future of Jobs Report 2018" (PDF). Archived (PDF) from the original on 9 February 2020. Retrieved 9 February 2020.
  15. ^ "Job Loss in the Italian and British Automobile Industries", Heroic Defeats, Cambridge University Press, 13 November 1996, pp. 40–65, doi:10.1017/cbo9780511625657.004, ISBN 978-0-521-48432-9
  16. ^ Sinha, Partha. "UTI SWATANTRA" (PDF). Archived (PDF) from the original on 6 August 2020. Retrieved 9 February 2020.
  17. ^ a b "6.1. Life expectancy has increased remarkably in OECD countries" (XLS). OECD. doi:10.1787/888933405548.
  18. ^ Wandel, William H. (June 1960). "Rising Medical Care Costs with Special Reference to Hospital Expenses". The Journal of Insurance. 27 (2): 65–68. doi:10.2307/250624. ISSN 1047-3483. JSTOR 250624.
  19. ^ Sekhri, Neelam (2000). "Managed care: the US experience" (PDF). Bulletin of the World Health Organization. 78 (6): 830–44. PMC 2560791. PMID 10916920. Archived (PDF) from the original on 10 April 2020. Retrieved 9 February 2020.
  20. ^ Chaudhuri, Shubham. (2003). The effects of extending intellectual property rights protection to developing countries: a case study of the Indian pharmaceutical market. National Bureau of Economic Research. OCLC 249394911.
  21. ^ "Personal Finance: The Allocation of Personal Wealth to Different Asset Classes", Pension Finance, John Wiley & Sons, Inc., 11 September 2015, pp. 67–76, doi:10.1002/9781119208945.ch2, ISBN 978-1-119-20894-5
  22. ^ "Financial Planning Curriculum Framework". Financial Planning Standards Board. 2011. Archived from the original on 13 August 2021. Retrieved 23 August 2021.
  23. ^ Kadlec, Dan (10 October 2013). "Why We Want—But Can't Have—Personal Finance in Schools". Time. Archived from the original on 6 October 2015. Retrieved 24 October 2015.
  24. ^ Antonia, Farzan (2 May 2015). "High schools are beginning to require personal finance courses. Finally". Business Insider. Archived from the original on 28 September 2015. Retrieved 28 September 2015.
  25. ^ "Survey of the States". Council for Economic Education. Archived from the original on 13 August 2015. Retrieved 28 September 2015.
  26. ^ "10 Best Personal-Finance Tools to Better Manage Your Money". Kiplinger. Archived from the original on 5 September 2015. Retrieved 28 September 2015.

Further reading[edit]

External links[edit]