Personal financial planning is a wholistic process through which individuals manage their monetary resources so that they can achieve their goals. While many people often practice one or two aspects of personal financial planning, few practice all of them.
Indeed, the most effective way to achieve financial freedom is to apply all five principles of personal financial planning concurrently. What are they? Let’s explore below:
Think of income as any money you earn. It is the first consideration of a personal financial plan because this amount generates the cash that you will use in all the subsequent steps. Some sources of income include a salary, bonuses, profit from a business, royalties, dividends from an investment, and rental income.
It is crucial to have an accurate picture of your monthly income. It is just as important to have more than one income stream so that in case one is disrupted, you are still able to maintain your standard of living. It is recommended that you maintain a healthy mix of active and passive income sources.
Spending involves paying for products and services that you will consume. Unlike investments, for example, you do not expect money you spend to be returned to you.
Spending is inevitable. In fact, a majority of most people’s income goes towards spending, whether it is paid for with cash or credit. The trick is to ensure that your expenses do not exceed your income, otherwise you will find yourself in debt.
Managing the amount of money you consume is very important. No matter how much you make, if your spending is out of control, you will constantly fall short of your financial goals. Food, clothing, shelter, travel, entertainment and taxes are some of the most common expenses.
Saving simply means setting aside surplus income for future use. It is a crucial component of financial planning because it gives you some protection in case of a financial emergency. For instance, out of those who lost their jobs during the Covid-19 induced economic crisis, the ones who had savings fared better.
Saving can also help you pay for goods or services which are too expensive for your income to cover. In addition, it can help you avoid debt and reduce your financial stress.
It is recommended that you save a certain percentage of your income before spending any of it.
While savings are important, having a large amount of money just sitting around is wasteful, especially if that money can multiply and create a new income stream for you. This is where investing comes in.
Investing is the process of buying an asset while expecting it to generate a return, which will eventually exceed the capital invested. Aside from the return, this practice allows you to outpace inflation, thereby maintaining the value of assets you currently hold. It may also reduce your tax burden and allow you to amass enough cash for big transactions such as to buy a home, pay for your children’s education or retire comfortably.
A key characteristic of investments is that they come with some level of risk and so you need to find a good balance between risk and return. It is also advisable to seek expert advice, especially if you are new to it so that you safeguard your capital.
If 2020 has taught us anything, it’s that life can be unpredictable and it is necessary to take steps to protect yourself and the people that matter to you.
Personal protection is, therefore, the step in financial planning which shields you in case of adverse incidents such as illness, loss of income or death. Some widely known protection products include life insurance, medical cover, income protection and estate planning.
Having known the principles of personal financial planning, the rest simply involves customizing the plan to suit your individual needs and then implementing it.
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