Personal finance is the application of the principles
economics to an individuals (or a familys)
financial decisions. It asks, How much money will you
need at various points in the future? and How
do you go about getting that money?. It deals with questions
What is finance?
What is my annual income?
How can I increase my income?
What are my annual expenses?
How can I reduce my expenses?
How do I best budget my available income each year?
How much money can I save each year?
How much will I accumulate over my working lifetime?
Will this be enough to support me after I retire?
How much will it cost each year after I retire?
How many years will I be retired?
How do I pay for large expenses (like childrens education,
or buying a house) when they arise?
How can I reduce my financial risk? Through insurance? Through
What do I do with the savings that I have accumulated? What
is the best way of investing this capital?
How much debt do I have? What are the monthly debt servicing
What is the value of my assets?
What effect will taxes have on these issues?
How do I minimize the taxes I must pay?
What effect will inflation have on these issues?
How will these issues change as I go through the stages of
A Question of Time
Personal finance is a detailed analysis of financial
flows at various points in time. For example, we may receive
employment income today, but have to pay college tuition fees
next year. Mortgage payments, interest earned, insurance premiums,
and numerous other financial flows are recurring events that
repeat at monthly or yearly intervals. Because these involve
several time periods, we have to ask What role does
time have in these financial calculations?.
We know that if we deposit money in a bank account we will
receive interest. Because of this, we prefer to receive money
today rather than in the future. Money we receive today is
more valuable to us than money received in the future by the
amount of interest we can earn with the money. This is referred
to as the time value of money. To adjust for this time value,
we use two simple formula. The present value formula is used
to discount future money streams, that is, to convert future
amounts to their equivalent present day amounts. The future
value formula is used to convert todays money into the
equivalent amount at some time in the future.
All personal financial planning done by professionals uses
these time value formula, as well as several more complicated
variants of the formulas. To ignore the role that time plays
in financial planning is to ignore one of the most important
principles of personal finance.
Financial Planning Process
Life Cycle - Financial Times