L1 Areas and Principles Of Personal Finance PDF

Lesson 1 AREAS AND PRINCIPLES OF PERSONAL FINANCE INTRODUCTION The discussion will focus on the areas and principles of personal finance as well as its importance to an individual. LEARNING OBJECTIVES 1. Explain the areas and principles of personal finance 2. Discuss the importan...

Lesson 1 AREAS AND PRINCIPLES OF PERSONAL FINANCE INTRODUCTION The discussion will focus on the areas and principles of personal finance as well as its importance to an individual. LEARNING OBJECTIVES 1. Explain the areas and principles of personal finance 2. Discuss the importance of personal finance LECTURE DISCUSSION PERSONAL FINANCE is the process of planning and managing personal financial activities such as income generation, spending, saving, investing, and protection. AREAS OF PERSONAL FINANCE As shown below, the main areas of personal finance are income, spending, saving, investing, and protection Income Income refers to a source of cash inflow that people and households receives to fund their lifestyles, save for the future and reach their financial objectives. It is the starting point of the financial planning process. Income may be derived from a variety of sources. These sources of income all generate cash that an individual can use to either spend, save, or invest. In this sense, income can be thought of as the first step in personal finance roadmap.  Employment - Regular pay - Overtime pays - Commissions - Bonuses/Tips  Operating a company - Business profit  Investments - Interest - Dividend - Rental income  Retirement - Pension Having multiple sources of income can facilitate savings and long-term financial goals, improve wages, and speed up the acquisition of wealth. It also increases financial independence and flexibility, enabling individuals to make decisions based on personal tastes. This flexibility can enhance work-life balance, lower financial stress, and allow individuals to pursue their hobbies or interests Diversifying sources is essential for risk management and efficient financial planning. It also aids in financial freedom, stability, higher earnings, risk diversification, flexibility, and independence. People with only one source of income are more susceptible to financial instability since it can result in job losses or downturns in the economy. Diversifying sources of income helps create a more stable financial portfolio by reducing the danger of depending entirely on one source of income.  Skills and interests: Assessing one’s skills, knowledge, and expertise in various areas and monetizing them can open the door to additional income sources. It includes exploring hobbies, interests, and passions that can be monetized.  Exploring freelancing and side gigs: Individuals can determine if they can offer services or expertise on a freelance basis for money through the exploration of talents within them. It involves seeking opportunities to provide freelance work or take on side gigs in their field of expertise or interest as others. Utilizing online platforms and marketplaces to connect with potential clients or customers can help.  Starting a small business: Individuals can explore viable business ideas based on market demand and skills for others. They can develop a business plan outlining goals, target market, and financial projections for the same. Considering e- commerce options to reach a broader customer base and securing necessary licenses, permits, and registrations are all part of this process.  Investing in income-generating assets: Researching in depth about investment options such as real estate, stocks, bonds, or mutual funds. Individuals can consult  with financial advisors or professionals to make informed investment decisions regarding the same. Considering passive income opportunities like rental properties or investing in high-quality dividend-paying stocks can also help.  Monetizing expertise or knowledge: Offering consulting services or becoming a subject matter expert in their industry can create additional sources of income. Developing online courses or educational materials to share knowledge is one option for developing online income sources. Individuals can also consider writing a book or an e-book or creating digital products related to their expertise.  Exploring rental income: Individuals can consider renting out extra space through platforms like Airbnb to make passive income. They can also evaluate the potential for long-term rental income by investing in properties in happening places.  Leveraging the power of the Internet: Individuals can utilize online platforms and marketplaces to sell products or services to earn through online income sources. Social media platforms are great for spreading such ideas. Spending Spending includes all types of expenses an individual incurs related to buying goods and services or anything that is consumable (i.e., not an investment). All spending falls into two categories: fixed expenses and variable expenses Fixed Expenses Fixed expenses are those that remain constant, although they may change occasionally. For example, you may switch to a new cell phone service provider, or your landlord may raise your rent. Fixed expenses are paid at regular intervals and may vary slightly, change significantly or stay the same, depending on the type of expense. Monthly fixed expenses are common, although fixed expenses may also occur weekly, quarterly, twice a year and yearly Examples of fixed expenses include:  Rent or mortgage payments  Car payments   Other loan payments  Insurance premiums  Property taxes  Phone and utility bills  Child care costs  Tuition fees  Gym memberships Fixed expenses can take more time to adjust, though it’s still possible to cut costs. Rent, for example, can be reduced by finding a cheaper home or apartment, but you may have to wait until the lease expires to avoid losing a security deposit or paying a fee. Variable Expenses Variable expenses change regularly and may be directly influenced by the choices you make day to day. Unlike fixed expenses, variable expenses can be less predictable and more volatile. Common variable expenses include:  Groceries and dining out  Clothing  Personal care  Entertainment  Gasoline  Home and car repairs  Medical bills Some variable expenses are much easier to adjust in a pinch. If an emergency expense comes up and leaves you short on cash for the month, it can be difficult to reduce fixed expenses like car or rent payments to make ends meet. Bringing down variable expenses, however, is usually possible. For example, you can trim your grocery bill and avoid dining out or purchasing nonessential items The expenses listed above all reduce the amount of cash an individual has available for saving and investing. If expenses are greater than income, the individual has a deficit. Managing expenses is just as important as generating income, and typically people have more control over their discretionary expenses than their income. Good spending habits are critical for good personal finance management Saving Saving refers to excess cash that is retained for future investing or spending. If there is a surplus between what a person earns as income and what they spend, the difference can be directed towards savings or investments. Managing savings is a critical area of personal finance. Most people keep at least some savings to manage their cash flow and the short-term difference between their income and expenses. Having too much savings, however, can actually be viewed as a bad thing since it earns little to no return compared to investments. Investing Investing relates to the purchase of assets that are expected to generate a rate of return, with the hope that over time the individual will receive back more money than they originally invested. Investing carries risk, and not all assets actually end up producing a positive rate of return. This is where we see the relationship between risk and return. Common forms of investing include:  Stocks  Bonds  Mutual funds  Real estate  Commodities Investing is the most complicated area of personal finance and is one of the areas where people get the most professional advice. There are vast differences in risk and reward between different investments, and most people seek help with this area of their financial plan. Protection Personal protection refers to a wide range of products that can be used to guard against an unforeseen and adverse event. Common protection products include:  Life insurance  Health insurance  Estate planning This is another area of personal finance where people typically seek professional advice and which can become quite complicated. There is a whole series of analysis that needs to be done to properly assess an individual’s insurance and estate planning needs. IMPORTANCE OF PERSONAL FINANCE The need for personal finance is multifaceted. Depending on each individual’s case, personal finance can offer a variety of benefits. For some people, it makes money management easier. For others, it streamlines their investments and financial plans. Let’s take a look at the broad reasons behind why personal finance is so important It helps to understand finances better Taking charge of money issues begins when one understands his/her finances better. One needs to get some basic questions sorted.  What’s your monthly budget like?  How much of your money do you spend on luxury products and services?  How much is spent on the things you really need?  What are your future requirements like? And by doing this, one gets a better idea of how much was earned, spent and saved. This lays the foundation for any and all financial plans that will be made in the future. It enables one to plan for investments When one consciously keeps track of his/her finances, it becomes easier to plan for investments. With clear goals in sight – both for the long term and the short term – one can invest smartly. It keeps one from taking on unmanageable debts When one takes charge of his/her finances, he/she can steer clear of debts that he/she knows he/she won’t be able to repay. This is one of the big upsides of making financial plans and tracking personal finances. It allows money and assets to grow Personal finance takes someone one step further than merely saving up for needs. It helps the money multiply by allowing him/her to choose the right investment options. In other words, personal finance is essential because it helps in creating wealth for a financially secured future. With the right kind of financial plans one can retire comfortably and fulfil his/her dreams and goals for the future. PERSONAL FINANCE PRINCIPLES Prioritization One needs to prioritize the areas that bring in the money, and ensure that income streams are sustained Assessment One needs to constantly and periodically assess his/her earning and spending habits, so that the income streams are optimized and expenses are minimized. Restraint Restraint ensures that one doesn’t spend more than he/she makes. In this age, when credit is so easily available, restraint is of utmost importance.