Personal finance, in my opinion, is a loaded term. There are various things a person could be referring to when they say personal finance. It could be debt, investments, taxes or simply budgeting. Those who are just starting out in their journey to master personal finance may become intimidated by the number of concepts that are wrapped up in this single phrase. I’m here to tell you this does not have to be the case. Before going down the rabbit hole of complex financial instruments, start by becoming intimately familiar with the 5 pillars of personal finance. These 5 pillars form the strong foundation that is needed to create a strategy that can lead to a financially fruitful life. Below, I outline the 5 pillars of finance and how to integrate them into your financial strategy.
1. Income
Income is the money you earn in exchange for products/services that you provide and is the first consideration in personal finance. Something unique about this pillar is the regular person does not have complete control over their income. This is demonstrated by persons earning hourly income. While they agree to the hourly wages, they do not set the amount paid per hour. They are also probably not the final decision maker in how many hours they work. Another example, for entrepreneurs, is they can set the price of their product/service but they have no control over the number of customers that make purchases. For those seeking to master it, they must ensure their income is greater than their expenses. While this may seem like a simple task, there are many who depend on pay day loans to supplement their income to get through the month. There is an important distinction to make here. Loans and credits are NOT considered income. There are debt obligations that you MUST repay at some time in the future.
If you are someone who is struggling to make ends meet, consider doing one of the following to increase your income:
- Ask for a promotion/raise
- Gain an in demand skill, then gain employment in that area
- Get a second job
- Start a side hustle by utilizing already existing skills and knowledge
2. Spending
If you talk to any financial professional, they will tell you the best way to increase your savings is to lower your spending. Any money that is subtracted from your net pay is spending. Unlike income you do have some control over how much you spend each month. To take control of your spending you must first determine what it is that you’re purchasing each month. The best tool to determine this is to use a home budget. I go into detail in this blog on how to create your own budget [How To Create Your Personal Budget].
One reason people really struggle with personal finance is because of their spending behaviors. Impulsive, emotional and social spending are just some of the habits young adults must overcome in order to take control of their finances. There are some that oppose this stance and recommend you work on increasing your income to support your lifestyle. I follow the philosophy of ‘live below your means’. Regardless of how much you make, if you have poor spending habits then you’ll always be in the rat race. Remember, the goal is always to ensure, at the end of every month, that your spending is LESS than your income. Try doing these simple activities to get a better hold of your spending:
- Create financial goals and stick to it
- Create a budget
- Automate savings to be transferred to an account
3. Saving
Savings is what is left over after you have paid all your bills, debt and expenses. This can be represented by the equation Savings = Income – Expenses. I like to think of savings as putting money away today that allows for more freedoms tomorrow. Saving is important for various reasons, but the primary reason is to cover unforeseen future events. For instance, if your tires blow suddenly while on the interstate highway, you can get home safely and have new tires in a week. All without having to go into debt. It is also important to make the distinction that your savings is for emergencies not to earn a return on your money. It should be held in an account where it is readily available for use when you need it. Usually these type of accounts offer little to no return. Here are some tips on how to boost your savings:
- Automate your savings to be transferred to another account
- Keep your checking and savings account separate
- Each time your pay increases, increase your savings amount
Savings = Income – Expenses
4. Investing
Investing is considered the riskiest of the 5 pillars of personal finance. It is buying a financial instrument with the expectation of earning a return on your money. The reason investing is risky is that the return is NOT guaranteed. In fact, you may lose a substantial amount of money through no fault of your own. There are, however, a plethora of investment options with varying degrees of risk for investors to choose from. Persons who are interested in investing should take the time to develop an investment strategy and do their due diligence. If a random person on the internet encourages you to purchase a particular instrument, do your own research to determine if that is the right investment for you. Remember, the key to successful investing is to buy low and sell high. Here’s a blog that describes what you need to know before investing [What They Don’t Tell Beginner Investors].
5. Insurance
Insurance is probably the least spoken about pillar and probably the most misunderstood. Regardless of your personal feelings about it, your financial health is compromised if you do not have adequate insurance. Insurance acts as a protection against large losses in the case of a negative event. For example, if you are at fault in an automobile accident and the driver of the other vehicle is severely injured, they can sue you for more than their medical bills. Having adequate insurance can protect you in that your insurance carrier can pay for that suit. In the case of a medical injury that leads to long term disability insurance can pay a percentage of your salary every month. And in the case of the breadwinner of your household dying, insurance can ensure your dependents are not left in financial stress.
As you develop your personal finance strategy, ensure that the 5 pillars of personal finance are included. You need income to cover your spending and your spending to be less than your income. Then savings that is left after spending a portion of your income should be used to build an emergency fund and invest. Finally, you need protection against certain events that can leave you in financial distress.