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Personal Finance
[ What is Personal Finance]



Personal finance is the application of the principles of financial economics to an individual’s (or a family’s) 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 like:

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 children’s education, or buying a house) when they arise?
How can I reduce my financial risk? Through insurance? Through pensions?
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 payments?
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 my life?

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 today’s 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.

The Financial Planning Process

The Financial Life Cycle - Financial Times

 

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