Purpose of personal finance
Many people think that personal finance is an object about how to save money. Yes, saving is quite an important issue in personal finances, but it is not their main topic at all. Paradoxically, personal finances do not focus on money either.
Let’s see how it looks like in the case of the older area of finance – corporate finance. The main goal of the science of corporate finance is to achieve the goals of a given company. This is usually the maximization of benefits for shareholders. Thus, corporate finance is the science of how to manage property resources in order to satisfy shareholders as much as possible.
Man’s goal is happiness in the broad sense of the term. Collecting assets is certainly not what ultimately gives happiness. Although it is nice to have a lot of money, they alone will not bring happiness. So personal finances cannot be about how to save money.
And that’s what personal finances are about. It’s about managing, protecting and using money in the way that gives us the most happiness. Personal finances do not revolve around money. They revolve around people and their happiness.
Personal finance planning process
As I mentioned in the previous chapter, personal finances are divided into two main parts: planning and management. Before you start managing money, you need to plan how to do it. The Personal Finance primer will therefore focus on the former.
The financial planning process may seem like a bizarre set of encrypted characters. But when we dismantle this complex process into smaller parts, it will become more understandable.
- Define the current situation.
- Specify where you want to go.
- Identify the obstacles that stand in the way to your destination.
- Design a written Financial Plan.
- Implement this plan.
- Regularly review and update the plan.
Definition of the current situation and objective
The first step in reading any map is to find where you are. Maps standing in public places (city streets, shopping malls) usually have a large sign with an inscription: “You are here. In personal finance, the way to determine where you are is to make a financial statement: a personal balance sheet and a personal cash flow statement. The financial statements will be discussed in the chapters:
People usually start to take an interest in personal finances when financial problems arise. Unfortunately, personal finance is not a collection of miraculous advice that will immediately heal your home budget. You have to wait for the effects of personal finance planning.
Depending on a person’s net worth, dreams and abilities, it can take one, five or even thirty years to achieve individual goals. Therefore, we divide the goals into short-term (about one year), medium-term (up to a few years) and long-term (up to a dozen or even several dozen years).
In personal finances there are a lot of individual issues and I will repeat it at every step – after all, personal finances are personal. Everyone can have different goals, different approach to finance, different possibilities – so they will plan and manage their finances in a different way.
Setting financial goals is quite complicated. Based on your values and dreams, you should discover what is important, and then estimate the forecast of your future in the form of a life cycle model and career plan.
Identification of obstacles
Many obstacles can stand in the way of achieving objectives, which need to be identified and decided on how to manage them. These obstacles can be external or internal. To identify external obstacles, changing economic circumstances need to be taken into account. To deal with internal obstacles, you need to be able to make choices and manage risks.
Nor should we forget that the long-term plan must take into account the variable value of money over time.
Design and implementation of the Financial Plan
When you know where you are, where you are going, what obstacles can prevent you from doing so and what you can do to deal with them, you can write it all down, thus creating your Financial Plan. It contains a life cycle with the most important events you expect in your life and the moments of achieving your goals.
It covers all areas of personal finance: spending, risk management, lending, investment, retirement and succession. Instructions on how to prepare the Financial Plan.
It can be said that, in a sense, the preparation of a financial plan completes the financial planning stage and allows you to move on to personal finance management. However, planning is actually a continuous process to which you will often return. When implementing the plan, you should review it regularly and, if necessary, modify it so that it is always up to date.
The crowning argument of opponents of planning is that life is unpredictable, something is constantly happening, something is constantly changing. It is impossible to predict the future. Even if you plan something, one event in a moment can change everything. All this is true. For me, however, this is not an argument against planning.
This view, if it is not just an excuse or an attempt to justify your laziness or fear, is based on a mistaken assumption. It assumes that the plan has its beginning and end. However, planning is a continuous process of constant updating and modification. Every significant change must be taken into account. The plan must be up to date at all times.
Saving is an important issue, but personal finances do not focus on raising money. Man’s goal is happiness, which can be achieved by using money in the best way possible for us. So personal finance is the science of how to manage, protect and use money in the way that will give us the most happiness. Personal finances consist of two elements: planning and management. The personal finance planning process consists of six steps:
- Determining the current situation by drawing up a financial statement.
- Determine where you want to go, which is to set financial targets. You do this based on your values and dreams. To plan your way to goals, you need to design your own life cycle model and career plan.
- Identify the obstacles that stand in the way of the goal. They can be external (economic) or internal (our own limitations and decisions).
- Design a written Financial Plan, taking into account the variable value of money over time and all areas of personal finance.
- Implement this plan.
- Regularly review and update the plan.