Personal finance refers to the method of correctly and effectively administering all one's assets. The first and main goal of personal finance is to make sure enough income is being generated, and to allot a specific portion of that income to cover household expenses. Any excess cash is put aside as a reserve to ensure continued financial security. Income can be generated from various sources such as dividends, interest or real estate, but most often refers to money received from wages or salary.
Together with knowing one's sources and total amount of income, personal finance dictates that one is familiar with all fixed and variable household expenses. Fixed expenses refer to items such as mortgage or rent payments, loan repayments and car payments. Variable expenses refer to items such as monthly outlays for utilities, groceries, medical needs and other miscellaneous expenses.
The next step after identifying income and expenses is creating a budget. Although to some extent, that has been accomplished simply by determining the monies that are coming in and the monies going out, nevertheless there is a need to set aside money for non-recurring expenses. Those are occasional or one-time expenses, such as a car repair, clothing purchases or the acquisition of other items.
Once all basic living needs and debt obligations have been identified, the next part of the process is to determine how much income remains. This surplus income enables the building of financial wealth. Surplus income should be set aside in a savings account, life insurance policies, a retirement plan and accounts to pay college tuition. The money set aside should be invested in stocks, bonds, real estate or other income-generating ventures.
Personal financial planning requires frequent and regular monitoring and reevaluation. There are five basic steps.
1. Assessing the situation -- In order to adequately assess one's personal financial situation, one should create a personal income statement and financial balance sheet. The balance sheet states the true value of all assets such as house, car, stock, bonds, bank account and other investments. A balance sheet must also list one's personal liabilities such as mortgage, bank loans and credit card debt.
2. Setting goals -- It is important to set goals to work toward, such as retiring at age 65 with a net income of $1 million, or purchasing a house in five years while paying the maximum mortgage payments of 25 percent of gross income. Mixing long-term and short-term goals is very common and is very helpful in financial planning.
3. Creating a plan -- In order to realize and accomplish one's goals, a financial plan is essential. The plan can include such ideas as investing in other instruments in order to spread risk and increase income, increasing one's employment income by working longer hours, and eliminating or reducing unnecessary expenses.
4. Executing the plan -- Executing the plan requires perseverance and discipline. It may be necessary to obtain professional assistance and advice from financial planners, lawyers, accountants and investment advisors.
5. Reassessing and monitoring -- As market conditions change, the financial plan may call for change and reassessment. A financial portfolio must be constantly monitored and investments must reflect current market situations.
In any financial plan, it is necessary to make sure that one has adequate protection against unforeseen risks, which can be categorized as disability, death, ill-health and long-term medical care. There are many other types of financial planning that one can use. Tax planning requires that one take advantage of all the incentives the government allows to reduce one's tax obligation. Retirement planning helps with planning how much it will cost to live once one retires and to make sure that one is adequately protected. Estate planning involves planning the disposition of one's estate while avoiding as much as possible the high estate taxes imposed by the government.