1      INTRODUCTION

Personal finance is the management of your money which includes saving, investing, and setting financial goals. Personal finance also includes areas like budgeting, banking, insurance, mortgages, investments, retirement tax and estate planning. It is the knowledge, instruments and techniques used to manage your personal finances. (Kenton 2022.) Personal finances include the process of planning and managing one’s financial activities. These financial activities include generating income, spending income, saving income, investing and protection. An individual’s personal finances can be displayed in a budget or financial plan. (CFI Team 2022.) Setting individual financial goals and desires is the creation of a plan on how to fulfil those needs within your financial constraints to make intelligent financial decisions (Kenton 2022).

2      INCOME AND SPENDING

2.1      Income

Income is where personal finance begins and is the entire amount of cash inflow that an individual receives. Income is the total amount of money brought in which includes salaries, wages, dividends, and other sources of cash inflow. (Kenton 2022.) The term income refers to the money or entity that a person has received in exchange for labour or products. Generally, income is the total earnings, but it can also have different definitions depending on the context. Examples of this are taxation, economic analysis, and taxation. Regarding a business, income is the revenue from selling products, services and interest and dividends. A business income is received into their cash account and reserved for the business. Hence income can be defined according to the context of its concept.

Depending on the quantity that is being measured, there are different terms for income. Within the types of income there is also gross income which displays the total value of a person’s salary or payments. Gross income does not account for any cash outflows that may occur. There is also net income which is the income remaining after having subtracted fees or taxes. In the cases of an individual earner, the amount that they have left after having paid for necessary expenses is called discretionary income. Taxable income is an individual’s annual total or gross income reduced by the exclusions, exemptions and deductions allowed under the tax law. Under income tax, the income is referred to by the type of revenue to determine whether it is a part of the taxable income. (Scott 2022.)

The three categories of income which are of main concern to the (US) taxpayer are ordinary income, capital gain, and tax-exempt income. Ordinary income included earnings, interest, regular dividends, rental income, distributions from pensions or retirement accounts, and social security benefits. Capital gains is the gains earned from selling assets that have appreciated in value. This includes personal residences and investments such as real estate, bonds, and stocks. Tax exempt income is the interest paid on specific bonds that have been issued by the governmental entities. (Scott 2022.) In Finland tax is paid on your salary and other income. The amount of tax paid depends on how much income an individual receives. (pwc 2023.)

2.2      Spending

Spending is the outflow of cash and typically where the bulk of an individual’s income goes. Spending includes rent, mortgages, groceries, hobbies, eating out, home, travel, entertainment and more. A critical aspect of personal finance is managing spending where spending is less than income. If this does not happen, then there won’t be enough money to cover expenses or likely the individual will fall into debt. (Kenton 2022.) Debt is a financial liability or obligation owed by one person, the debtor, to another, the creditor (Solutions 2022).

Consumer spending refers to the total amount of money that is spent on final goods and services by individuals and households with the purpose of personal use and enjoyment within an economy. Spending includes private purchases of durable goods, nondurable goods and services whilst also being considered complementary to personal saving, investment spending, and production in an economy. Spending and consumption of final goods comes as the result of and motivation for economic activity since all goods that are consumed must also be produced first. Consumer spending plays a key role in the demand aspect of the “supply and demand”. Regarding consumer spending consumers choose the time of when their income is spent whether that be now or in the future. If income is retained for future spending, then this is called saving whereas consumer spending typically refers to present consumption spending. (Potters & Li 2021.)

3      SAVING, INVESTMENT AND PROTECTION

3.1      Saving

Savings is the income that is left after spending. The aim for savings is to have enough to cover large expenses or emergencies from somewhere between three and twelve months of expenses. Beyond the figure of savings for expenses and emergencies, any cash that is left idling in a savings account becomes wasteful due to inflation and its loss of purchasing power. Money that is not an emergency account or spending should be placed somewhere to maintain its value or grow and this includes investments. (Kenton 2022.) When an individual subtracts their consumer spending from their disposable income from a given period of time they are left with their savings. Savings is the net surplus of funds that a household or individual holds once expenses as well as financial obligations have been paid for. Savings are typically kept in cash or a cash equivalent to minimize risk of loss, however this also presents minimal returns. Within lifetimes, people save towards their goals and aspirations which could include retirement, children’s college education, down payments for homes or cars, or vacations. The phrase “living paycheck to paycheck” is used for those who are incapable of maintaining their savings. (Kagan 2022.)

There are a variety of savings accounts that are offered by banks, and each consist of different features and limitations. The first type of account is a savings account, which typically has a low interest rate. Deposits into a saving account and withdrawals from savings accounts are made either online, by phone, mail, at a physical bank branch or at an ATM. The next type of account is a checking account, also known as a basic payment account, which is used to write checks or use a debit card to withdraw money from the account. The majority of basic payment accounts have no interest which comes at the price of the account being highly liquid and funds are accessible with low or without monthly fees. (Kagan 2022.)

3.2      Investing

Investing is the purchasing of assets which can be stocks, bonds, funds or property. These are bought to earn a return on the money that has been invested to increase an individual’s wealth beyond the amount they invested. Howvere investing comes with risks and not all assets appreciate but can incur a loss. (Kenton 2022.) Investments that have been bought increase in value over a period of time and typically are able to provide returns in the form of an income payment or capital gains. Another perspective on investing is the notion of spending time and money to improve an individual’s quality of life and in addition to this the lives of others. Within finance, to invest is to purchase securities, real estate, and other items in exchange for future potential capital gains or income. (Napoletano & Curry 2022.)

When investing, the asset is bought at a low price and is then sold at a higher price. The return is often referred to as a capital gain and when an investment increases in value between the time frame of when it is bought and sold is called appreciation. Investments that could appreciate in value are shares of stocks, corporate bonds, commodities like gold and homes or condos. Investing not only includes the profit of capital gains and appreciation but also through buying and holding assets that generate income. This works by buying assets that generate cash flow over a period of time by holding on to them without having to sell. An example of this are stocks that pay dividends, where the stocks provide dividend income. There are four main asset groups which can be invested in by investors. These classes are stocks, bonds, commodities, and real estate. Alongside this there are also mutual funds and exchange traded funds (ETFs) which work by buying different combinations of assets. This type of investing method is the combination of hundreds and thousands of individual assets. (Napoletano & Curry 2022.)

Stocks are also known as equity, and they are a security that represents the ownership of a part of the issuing corporation (Hayes 2022). By buying a share of a stock, you are granted partial ownership of the company which allows you to participate in its gains and losses (Napoletano & Curry 2022). Shares are the units of the stock and they entitle the owner of the stock to a proportion of the corporation’s assets and profits, which equals the value of how much stock they own. In most cases stocks are bought and sold from stock exchanges and generally tend to be the foundation for many individual investors in their portfolios. The government regulations which the stock trade has to conform to are done so that investors are protected from fraudulent practices. Stocks are issued by corporations to raise funds to operate their business. The individual who holds the stock, also known as a shareholder, can have a claim to part of the company’s assets and earnings. Shareholders are considered owners of the issuing company and their ownership is determined by the number of shares they own relative to the number of outstanding shares. Ownership by stockholders does not mean they own a corporation and corporate property is legally separated from the property of shareholders, limiting the liability on both the corporation and the shareholder. Meaning a corporation were to go bankrupt and all assets were ordered to be sold by a judge, the shareholders assets would not be at risk. Shareholders own the shares that have been issued by a corporation. With shareholder ownership, the ownership of stock gives the individual the right to vote in shareholder meetings, receiving dividends if and when they have been distributed as well as the right to sell shares to another individual. In the case of owning a majority of shares, then voting power has increased causing indirect control of the direction of the company through appointing its board and directors. This scenario is most apparent in acquisitions when one company buys another and the quiring company has bought all the outstanding shares. Stocks are bought and sold on stock exchanges after a company has gone public through an initial public offering (IPO). From this investors use a brokerage account to purchase the stock at the purchasing price (the bid) or sell (the offer). Investments are risky and hold the possibility of love value if the market conditions have declined. (Hayes 2022.)

In situations where a company and countries need capital, they are able to borrow money from investors by issuing debt, this is called bonds. Bonds permit an investor to “become a bank”. Investing in bonds is loaning money to the issuer for a fixed period of time. In exchange for the loan, the issuer pays the individual a fixed rate of return in addition to the money that had originally been loaned. Bonds are typically less risky than stocks as they hold fixed rates of return and are known as a fixed income investment. Commodities are products that are agricultural, energy or metal which includes precious metals. Most commonly these assets are raw materials that are used by an industry. These products prices are dependent on the market demand. To buy physical commodities is to hold quantities of oil, wheat, and gold however the alternative is to invest in the commodities by use of futures and options contracts. Investing in commodities can also be done by other securities such as ETFs or by buying shares of companies that produce the commodities. Investing in commodities is quite a high-risk investment and is commonly for more experienced investors. Investing in real estate can be done by buying homes, buildings, or pieces of land. The risk level of real estate investments can vary on factors like economic cycles, crime rates, public school ratings and local government or council stability. A method of investing in real estate without owning or managing the real estate directly can be done by buying shares of a real estate investment trust (REIT), which uses real estate to generate income for shareholders. These traditionally pay higher dividends than other assets. A mutual fund or ETF invests in stocks, bonds, and commodities by a particular strategy. Funds allow an individual to invest in hundreds or thousands of assets following the purchase of their shares. Funds are an easy method of diversification that are typically low risk in comparison to individual investments. (Napoletano & Curry 2022.)

3.3      Protection

Protection is the methods people take to protect themselves from unexpected events, which could be illnesses or accidents, acting as a means of preserving wealth. Protection methods include life and health insurance alongside estate and retirement planning. (Kenton 2022.) Health insurance covers portions of medical expenses and helps to pay for doctors’ visits, hospital stays, medication, tests, and procedures. Health insurance is available with the purpose of ensuring individuals can afford their medical care. Life insurance is paid as a lump sum to an individual’s beneficiaries in the case of premature death. The sum that is paid should be sufficient to compensate for the future income loss. In addition to this the sum covers expenses and obligations which include funeral costs, medical expenses, debts, college savings and retirement years. Life insurance is important when an individual has a family as a financial safety net. (Kurt 2022.) Retirement planning is determining retirement income goals and observing what must be done in order to achieve those goals. This includes identifying sources of income, estimating expenses, creating a savings programme whilst also managing assets and risks. To observe whether retirement is possible, it is important to observe future cash flows. (Kagan 2023.)

4      SETTING FINANCIAL GOALS AND BUDGETING

4.1      Budgeting

A budget is crucial in living within one’s means and saving enough for long term goals (Kenton 2022). Individuals, families, groups, companies, and governments carry out budgeting in order to plan, monitor and control their finances. The two crucial components of budgeting are the expected revenue and estimated expenses. Expected revenue refers to an individual’s, businesses entity or governments potential cash inflow. The estimated expenses are the expectations an individual, firm or government holds for their cash outflow. There are different types of budgeting that can be used. The first being a personal budget which is an individual or a family’s plan for their earnings and expenses for the month to prevent running out of cash before the next paying month. Corporate budget refers to the plan of maintaining cash flow, operating cash, and emergency funds efficiently. This includes sales, material, factory overheads and production. A government budget is prepared by federal government accounts for an estimation of the national revenue for a financial or fiscal year. Master budget is a culmination of lower-level budgets in regards to business operations. Operating budget refers to the reflection of the profit and loss accounting accounts. Static budget is by the government and non-profits and is rigid. A flexible budget is the realistic approach by business. Financial budget includes assets, liabilities, and shareholder equity. A cash budget is the cash flow that has been prepared in advance. Lastly a labour budget is specified for labour intensive firms. (Vaidya.)

Budgeting can be done incrementally, participative, negotiated, value proposed or zero based. To budget, a goal has to be first established. It is good to interpret and compare old documents of revenue and expenses. (Vaidya.)

4.2      Setting financial goals

Setting financial goals for the short term and long term is an important step towards becoming financially secure. The process of setting financial goals should be ongoing to fit alongside your life and goal changes. By financial planning annually you can formally review progress, goals and make updates. (Fontinelle 2022.) Financial goals are the plans you have for your money and by being specific you can decide and choose where you put your money. By having financial goals, you are able to have a better perception as to where you want to spend your money and where you are spending it. Financial decisions that are made with a plan aid to your overall financial health. By being intentional with your money, you can spend more wisely and do more of the things you want to as well as plan to do. Setting up financial goals means you must be specific as to what you are aiming to achieve within your finances. Once the goal is specific you must make it measurable so that you can review and know whether you are hitting your goals or not. By breaking down the goal into smaller aspects, it prevents the feeling of defeat or a goal feeling too far in the future. To avoid procrastinating on your goals it is good to give yourself a deadline that is reasonable and a bit challenging. When writing down your goals it is also important to ensure that the goals you set are your own and not someone else’s or societies expectation of your finances. Commonly people set financial goals by creating and sticking to a budget, building an emergency fund, getting out of debt, saving for retirement, and spending less in order to save more. (Cruze 2022) When setting short term and long-term financial goals it is important to have S.M.A.R.T financial goals where the system can aid in identifying and achieving goals. S.M.A.R.T is an acronym for specific, measurable, attainable, relevant, and time bound. By being specific the goal should be able to identify what is being saved for. Measurable and attainable ensures you have an exact figure that is realistic, and you are able to develop strategies to ensure it can be achieved. Relevant goals are compatible with your situation and finances. Having goals that are time bound keeps accountability for the financial goals. The short-term goals are what money will be spent on in the next couple of months or years which can be done by setting budgets, plans for paying loans or debt and starting an emergency fund. (Calidano 2022.) The long-term goals are typically applied to major life events and take longer than five years to accomplish. (Mint 2022.)

4.2.1     Short term and mid term

In order to establish short term goals it is good to create a budget, emergency fund and plan for paying off credit cards, loans or debts. Budgeting is a good method of tracking spending and keeping all financial information in one place. By budgeting you can see where your money is going and track spending allowing better decisions to be made. Having clarity on where your money is going creates an opportunity to see where money can be saved and where it can be spent. An emergency fund is the money that has been set aside for unexpected expenses. The aim is to set a small goal at first and when that goal is met, it can be expanded to be able to cover greater financial difficulty. An example of greater financial difficulty is unemployment. The recommendation is to have at least three to six months’ worth of expenses. When dealing with paying off credit cards and debt, it can be done prior to having an emergency fund, after having an emergency fund or at the same time as building an emergency fund. A strategy for paying off debt is to list the interest rate from lowest to highest, then paying the minimum on each of the debts except the highest rate debt. On the highest rate debt, it is recommended to use additional funds to make extra payments. (Fontinelle 2022) Short term financial goals can also include saving for holidays and vacations or weddings alongside debts and emergency funds. Short term goals are what is wanted to be achieved within the next couple of years. During the creation of financial goals, it is important to track spending and expenses to be able to see where money can be redirected or where money has been overspent. There are different apps and tools for tracking spending alongside the conventional tools such as excel. Whilst tracking spending, a realistic budget can be made based on what has been spent and where money has gone. (Califano 2022.)

After creating your short term goals, you can begin to create midterm goals which bridge short term and long term goals. These goals consist of getting life insurance and disability income insurance, paying off student loans and considering one’s dreams. (Fontinelle 2022.) The midterm goals often overlap the short- and long-term goals. These goals can take between one to five years to accomplish and share characteristics of both long and short term goals. (Mint 2022.)

4.2.2     Long term

Typically the biggest long term goal that is set by people is to have enough money for retirement. In order to do this, you need to estimate your retirement needs and how much you need for retirement to be possible. This can be done by estimating your desired annual living expenses during retirement which can be prompted by your current budget to get an idea. However, it is also important to take into account specificities like healthcare costs. Within your retirement plan it is also good to estimate the income you will receive from pensions, social security and the government, and retirement plans. These long-term goals can be changed and updated as you reach different moments in life to suit your current finances and life goals. (Fontinelle 2022.) Long term financial goals are considered to take more than five years to be accomplished. They avoid only focusing on one’s current situation but bring awareness to the future and ensure preparedness for future life events. The long-term goals are typically focused on major life events and often require re-evaluation periodically. Long term goals can also include saving for a house deposit to own property and build equity in an appreciating asset. The deposit value is dependent on the cost of the desired property and other aspects such as guarantors, purpose of the property and whether you have other assets for collateral in lending. Within long term goals it is also important to not only focus on where money is being spent but also how earnings potential can be increased. This includes evaluating your career path and looking at how those career goals can be achieved by either promotion, studying and career changes. Whilst setting goals if applicable you can take the chance to improve credit score to aid getting better interest rates and mortgage loans. Credit score can be improved by rent being paid on time, using less than the credit limit, paying off credit in full each month, and settling delinquencies. Effective financial planning for the long term also includes creating a will and testament to allocate assets and money after death. This aspect of financial planning is important to be discussed with an estate planning attorney. Within long term financial planning there are other aspects to consider later in life such as saving for your children’s education (if applicable), paying off any new debts that may have accrued, and evaluating life insurances. (Mint 2022.)

5      CONCLUSION

To conclude personal finances, include many aspects such as budgeting, setting goals, investing, protection, saving and spending. It is important individuals are aware of their personal finances to be financial healthy and achieve financial goals. Each aspect of personal finances are important to learn and be aware of to improve one’s finances. There are many tools available to aid the process of working with personal finances and it is important to figure out which is most suited. (Kenton 2022.)

REFERENCES

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