Five Must Know Personal Finance Basics

What are the primary financial basics everyone needs to know? Below is a list of some key concepts that will help to build a solid foundation.

Budgeting

Of all the financial basics, budgeting is the most critical skill to master. Knowing how much money is coming in and how much is going out is basic.

Most people know where their income is generated from. Most people have a job and the paycheck is the major or only income source. Having to live from paycheck to paycheck makes a lot of people keenly aware of how much money is coming in.

What most people don’t realize is where their money goes to. We now live in a society where you can buy most anything 24 hours a day. Coupled with the rampant materialism, keeping track of where you spend your money can be a difficult task.

Actually, setting up a budget is fairly simple. The hard part is developing the habit of tracking income and expenditures on a weekly or monthly basis. The exercise of recording transactions will help clarify where the money comes from and goes to.

For the individual, you have the flexibility and freedom to “work” your budget. You can make adjustments and reap the benefits and consequences in the privacy of your own mind.

When you are married or have someone else you are sharing your life with, budgeting becomes complicated and stressful. Key to making the process as easy as possible is to:

  1. agree on goals
  2. be honest with each other
  3. be flexible
  4. be gentle with each other
  5. set a time (weekly or monthly) to work on the budget together

Budgeting provides the information to help make decisions. It provides a road map to help make daily decisions.

Saving

Developing the habit of saving a portion of your income consistently can be key habit that provides security in old age. Savings will also provide options and opportunities in the future. In the US, the habit of “saving for a rainy day” has been lost. For 2013 the United States is projected to rank 18th out of 26 of the most industrialized nations in the world. Only Hungry Korea, Canada, Japan, New Zealand, Finland, Estonia and Denmark rank behind us.

Having savings provides an asset that can help in a multitude of ways. If you develop enough savings, you can invest in income producing assets. Wealth builds on wealth.

One of the shortcomings of the US educational system is the lack of financial training. Fortunately the internet has an abundance of information about saving, investing and managing finances. The bedrock of all financial success is the habit of saving.

Compound Interest

Gaining an understanding of how compound interest works and its power over time is a key concept. Learning about the impact of compound interest early in life will allow a few savings “seeds” to grow into “trees”.

An example is putting $1,000.00 into savings. After 20 years it will grow to:

At 2% interest – $1,485.95

At 3% interest – $1,806.11

At 4% interest – $2,191.12

At 5% interest – $2,653.30

If you add $1,000.00 each year for 20 years the results would be:

At 2% interest – $26,269.26

At 3% interest – $29,482.60

At 4% interest – $33,160.32

At 5% interest – $37,372.55

As you can see, over 20 years the compounding effect can be tremendous. The earlier you start, the more impact compounding has.

Insurance

Understanding and using insurance is another basic skill to have. We all know insurance is required if you own an automobile. New legislation is requiring all US citizens to have medical coverage as of January 1, 2014.

So, what is the big deal about insurance? In a nutshell, it helps to moderate risk. This is the risk of loss due to injury, accident or death.

What type of insurance coverage do you need. How much coverage do you need of each type. And, how much should you be paying for it. The answers to these questions change over an individual’s lifetime. They must be assessed periodically. Grasping the concepts and knowing where to go to get correct and relevant information is key for everyone.

Diversification

This concept not usually on everyone’s must know list, but I feel it is an important concept to grasp and apply.

The ability to protect yourself from risk by putting your assets in different investments is the most common application. However, you need to understand income sources need to be diversified.

Relying on one job for your income can be very dangerous. Long gone are the days when you started with a company and 30 or 40 years later you retired with a pension. In today’s world, you are the “Chief Executive Officer” of your life. You can specialize in a profession, but you need to be flexible in your skills set to be able to change jobs, move into a different career or move to a different area of the country.

There are no guarantees in life and you have to acquire, nurture and develop skill sets and income sources to protect yourself and your family.

Spend time exploring this concept. The more diverse your skills are and the people you know, the better off you will be.

The above are what I feel are must knows for everyone. If you develop an understanding of the above concepts, you will have a sound basis for developing and growing a viable financial future.

One thought on “Five Must Know Personal Finance Basics

  1. This is a great foundation that newer investors can rely on. Sometimes you get so caught up in the investment information that exists everywhere, you can get overwhelmed with advanced information before you start on the bare bones basics.

    Skill diversification is definitely interesting, and something you can do in your free time with tools like iTunes and Khan Academy courses. You can learn about all kinds of new things… even investing!

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