A Beginners Guide to Personal Finance
The subjects of personal finance and managing money are daunting. Money is all too often a taboo subject scarcely discussed, which contributes to the epidemic of financial illiteracy today. Unfortunately, these skills are critical to financial success.
If you are interested in learning about personal finance, it can be hard to know where to start. In this article, I will outline the – and i want to stress this – BASICS of personal finance. This article aims to cover just the most essential personal finance concepts and is by no means all-encompassing.
Start early
Learning about personal finance from a young age – even as early as a teenager – helps you build good habits that you will have for the rest of your life, learn things the hard way when the stakes are low, and take advantage of compound interest.
Many people never learn about personal finance or know about it late in their lives. Although learning about personal finance late is better than never, learning these crucial concepts will be significantly less impactful later in life. However, if you learn about personal finance and begin building healthy money management habits from a young age, you will be able to take full advantage of the benefits of personal finance.
Additionally, beginning to learn about financial literacy from a young age will help you to:
- Build robust habits that will help you later in life
- Learn lessons when the stakes are low
- Take advantage of compounding interest
Learn about financial literacy
Financial literacy is the foundation of personal finance, and being financially literate will make navigating personal finance concepts possible.
“Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. Financial literacy is the foundation of your relationship with money, and it is a lifelong journey of learning. The earlier you start, the better off you will be because education is the key to success when it comes to money.” – Jason Fernando, Investopedia.
Being financially literate means, you have a thorough understanding of all of the important personal finance concepts such as compound interest, how credit cards work, investing terms, various acronyms, etc. This means you will be able to stay informed about personal finance and begin implementing personal finance ideas into your habits.
To begin your journey to become financially literate, I recommend choosing an area to learn about. Whatever is most relevant to your life would be a good place to start (e.g., you inherited $10,000 and want to learn how to invest it.) As you start researching, you will inevitably encounter terms you don’t recognize. Instead of skipping over them or inferring their meaning from context, take the time to look up what they mean.
Chances are a Google search, and 5-minute article will be more than enough to explain the term/concept.
You can also read books or watch personal finance YouTubers if you want to take a different approach or just switch things up every once in a while.
Emergency fund
An emergency fund is a pool of money you set aside only to use in case of a, well, emergency. This could include a medical issue, the loss of your job, or any other emergency that requires money.
In case of an emergency, you will have money to use instead of taking on debt, selling investments prematurely, selling your possessions, having to cut back spending in other areas, etc.
To create an emergency fund, decide on the amount of money you want to have in it. The common advice is to have enough money to live off of for 3-6 months comfortably.
With this target in mind, take a percent of what you would typically save/invest and transfer it to a separate account. Because investing in securities can be volatile and slow to liquidate, investing this money isn’t a great idea. However, if you want to make interest on this money, there is another option. You can contribute to a high yield savings account, which typically yields from 0.25% to 2%, depending on the year.
Budget your money
Building income is important, but managing the money you make is equally important. One of the biggest parts of managing money is limiting your spending. The difficulty of this depends vastly from person to person, but it’s critical for everyone to decrease their spending, regardless of how naturally saving comes to them.
The simplest way of reducing your spending is to create a budget for yourself. In order to create an effective budget that isn’t too hard to stick two but also significantly reduces your spending will take a lot of trial and error, but there are ways you can make finding the right budget easier.
First, I recommend tracking and categorizing your spending for 1-3 months in a spreadsheet. And please be honest with yourself; no one else besides you will see your budget, so lying about your spending only serves to stunt your financial progress.
Then, add up your average monthly spending by category. This should give you a good idea of how much you spend on different things like food, clothing, bills, misc, etc.
Now, look through your category to identify where you are spending too much money. With this in mind, create a budget that takes you out of your comfort zone and cuts down on unnecessary spending.
Try your best to stick to this budget, and at the end of each month, alter this budget to reduce your spending as much as possible, but still live a comfortable lifestyle.
Investing
Investing in stocks, real estate, commodities, bonds, and cryptocurrencies is the best way of making money for many reasons, but chiefly because the amount of money you make is not proportional to how much time you spend. When it comes to a regular job, the more you work, the more you get paid, but investing is simply not the same.
Once you decide on the allocations for your portfolio, you can keep adding more and more money without doing any more work. All of the money you make is completely passive after putting in the initial effort. In other words, investing is easily scaled.
What makes investing especially lucrative is compound interest.
“Compound interest accrues and is added to the accumulated interest of previous periods; it includes interest on interest, in other words.” – Steven Nickolas, Investopedia.
This means that over time investments grow exponentially. For example, if you invested $100 with an annualized rate of return of 10%, it would be worth over $1000 in 25 years. Given another 25 years, that original $100 would grow into almost $12,000.
And although it may sound difficult, investing is quite simple. Anyone can open up a brokerage account, transfer money to it, and with a few clicks, buy stock. Even as a teenager, you can begin investing in stocks and other securities through a custodial account.
“The term custodial account generally refers to a savings account at a financial institution, mutual fund company, or brokerage firm that an adult controls for a minor (a person under the age of 18 or 21 years, depending on the laws of the state of residence). Approval from the custodian is mandatory for the account to conduct transactions, such as buying or selling securities.” – Troy Segal, Investopedia.
I want to be clear that while investing is not hard, it’s difficult to predict how a specific company will perform – especially for beginners – so you have to be smart about how you invest. Instead of investing in individual stocks, which is risky, consider investing in index funds.
An index fund is a large basket of stocks that seeks to track a stock index like the S&P 500. These large funds approximate the average market return because of the number of stocks included in many index funds. Investing in a fund like this almost guarantees that you will make money in the stock market and requires even less work than investing in individual stocks.
Here are some more in-depth articles about investing:
Track EVERYTHING
Tracking your budget, income, and financial progress might seem unnecessary but is a critical part of financial success. Tracking your finances will allow you to analyze trends, set effective goals, and have an accurate picture of your finances.
To begin tracking your money, create a spreadsheet with different tabs for each part of your finances. I personally have a tab for net worth, investments, cash on hand, budget, and goals.
Once every month, or however frequently you prefer, input the values of your investments, update your budget, and review your goals. Make sure to keep your data from previous months so you can look back and see your progress over time. For some of the tabs – for example, if you are tracking your spending – you might update your spreadsheet every time you make a purchase.
Doing this will allow you to analyze trends and help give you a clearer picture of your personal finances.
Set goals
Now that you know all of the most important parts of personal finance, what’s next? Now it’s time to set goals.
Having goals for your finances will give you something specific to work towards, which will help you to maintain motivation on your wealth-building journey.
To set a good goal, make sure it is the following three things: specific, quantitative, and realistic.
It’s critical that the goal you set is specific, meaning it specifies exactly what you want to achieve.
Your goal should also be quantitative, meaning it should be measurable and numerical.
Your goals should most importantly be realistic but not easy. You should design your goals to push you to work much hard but still be realistic, so you don’t lose motivation if you don’t meet them.
An example of one of my goals that I set taking into account these things was actually for this website. My goal was to have 100 visitors a month by the end of the first year I was posting and have 1000 visitors per month by the end of the second year. This goal is specific, quantitative, realistic, and not too easy or unrealistic to complete.
Plan for the future
Similar to setting goals, planning for the future is a pivotal part of financial success. This is especially important as it relates to increasing your income and saving for the future.
If you are currently in high school, think about what you want to do in the future. There are many different paths you may choose to follow after high school, but the most common path is college. On average, going to college is the most realistic way to make a lot of money (link), which is why many people choose to go to college. Going to a prestigious college will lead to an even higher income.
While community college is an option, graduates, on average, make much less than those who go to a four-year university.
So just go to university, right? Well, it’s not that simple. To get into a university (especially a good one), you have to have excellent grades, participate in extracurricular activities, etc. Knowing if you want to go to college and what caliber of school you are trying to get into is important in informing what you do in high school.
Whatever you decide to do after high school, make sure you take the necessary steps to do what you decide to pursue successfully.
Next steps
As I mentioned, this article only scratches the surface of personal finance. For more information about personal finance, I suggest reading these articles:
I also recommend reading books and other blogs about personal finance to gain a deeper understanding of it.
