Personal finance includes a broad range of products and systems an individual or family uses to budget, save, and spend monetary resources. Managing personal finance may include saving money, tax planning, paying for college, credit and debt management, building credit, guarding against identity theft, taking advantage of coupons and/or bargain shopping, executing wills and estate planning, learning about other monetary systems such as bitcoin, and in the worst case scenario, possibly even bankruptcy. Effectively handling personal finance requires a balancing act of several areas of life competing for limited resources and includes evaluating risks and consideration of future life events.
Saving money is the backbone of personal finance and is essential to building wealth. People save to build an emergency fund, save for retirement, and save for a large purchase such as a home, car, or education. No matter the goal, the first step to saving money is creating a budget. A budget is a plan for future income and expenses that can be used as a guideline for spending and saving. The key to saving money is to know your expenses, spend less than you make, and set aside the difference for the future.
Budgeting starts with tracking all income and expenditures a period of time, typically a month or more. Some expenses are fixed, such as rent or insurance payments. Other expenses are flexible and change from month to month, such as amounts paid for food and entertainment. Once all income and expenses for a month have been gathered, total expenses are subtracted from total income. If the result is a negative number, expenses will need to be reduced immediately to begin living within one's means.
A wealth of budgeting spreadsheets and software are available online and there is no one perfect method for every individual or family. Creating a budget that can be followed successfully may take time and involve some tweaking.
Many people dread tax time because whether they receive a refund or owe additional tax, it's a surprise. They earn and spend throughout the year with little regard for taxes, then hope for the best come April 15th. Gaining some basic knowledge of how taxes are calculated is an essential component of personal finance. At a minimum, one should know whether the standard deduction or itemized deduction will offer the greater benefit. In addition, being aware of applicable tax credits for education, child and dependent care, and the earned income tax credit will help with tax planning and determining what kind of records to maintain. The website 360financialliteracy.org, a public service website sponsored by the American Institute of Certified Public Accountants, provides a free 1040 Tax Calculator for estimating tax liability.
Many times, tax-saving moves can be made prior to year-end that can significantly reduce an individual's tax liability. Spending a few minutes reviewing retirement plan allocations, contributions to Flexible Spending Accounts (FSAs) or Health Savings Accounts (HSAs), and charitable contributions can reveal opportunities to reduce taxable income.
Paying for College
Higher education costs are an important aspect of personal finance management for anyone considering higher education for themselves, their children, or grandchildren. According to a study by the U.S. Department of Education, for the 2012-2013 academic year, the overall annual cost for a college education ranged from approximately $15,00 at a public institution to $39,000 at a private nonprofit institution. Those numbers can be disheartening, but students and their families should know that the 'sticker price' of a college education is typically not what the average student will pay. Other factors can be taken into account, such as tuition discounts, accelerated programs that allow students to graduate in a shorter time, advanced placement courses taken in high school that reduce the number of college credits needed for a degree, and other sources of tuition assistance and financial aid.
Student loan debt has received a lot of media attention lately. A recent analysis of student loan trends from the credit bureau Experian found that student loan debt increased by 84% from 2008 to 2014, surpassing the debt related to home equity loans and lines of credit, credit cards and automobiles. Clearly, families and students need help paying for college. When saving for education, time is of the essence. If the child is young, it may be beneficial to open a tax-advantaged savings account such as a 529 Plan or an Education Savings Account. These plans allow families to set aside funds to pay for higher education costs. Amounts contributed to the plans are allowed to grow tax free and distributions from the accounts are tax free as long as they are used to cover qualified education expenses. Many states also provide state income tax incentives for contributing to 529 Plans.
If the student or family does not have the resources to pay for college from savings and income, student loans can be an option, if used wisely. Borrowers should take care to not take out more debt than they can reasonably expect to be able to repay at a later date. Parents of college-age students may also consider taking out a home equity loan. In some cases, the interest paid on the loan may be allowed as an itemized deduction on the parent's income tax return. There are also tax incentives for paying for higher education including tax credits and deductions for student loan interest. Students and their families should weigh all available options.
A 2012 survey showed that 40% of low-and-medium-income households relied on credit cards to pay for basic needs such as rent, utilities, insurance, and food. Borrowing more than they can afford costs families in more ways than one. Paying just the minimums on credit cards can result in debts taking decades to pay off and often ends up costing more than the amount originally borrowed. Taking on too much debt also lowers credit scores, resulting in higher interest rates on all consumer and mortgage loans. A low credit score may keep people from renting an apartment, getting utilities, and even getting a job. Personal finance includes effectively managing credit to take advantage of lower interest rates and fees, freeing up additional money to be set aside for emergencies, retirement, and other expenses. Effective credit management includes establishing credit, paying as agreed, and keeping a low debt-to-credit ratio.
Building credit begins with the first credit card or car loan a person opens in his or her name. Many banks and credit unions are reluctant to extend credit to someone with no credit history. In that case, it may be possible to obtain a secured credit card. Secured cards require a cash deposit and are typically used to build credit. By making on-time payments and maintaining account balances below credit limits, a secured card can help build credit history.
If an individual has responsibly handled a checking account, the bank may be willing to extend a small personal loan. As the debt is repaid, the borrower establishes a credit history. Department store or gas cards may be available to borrowers without an established history. Because these cards have lower credit limits and may be used only with the companies that issue them, the lending guidelines may be more liberal, however, they often bear a higher interest rate than major credit cards so caution should be taken.
If credit has been mismanaged in the past, rebuilding credit will take time. Ads on TV and online that promise a quick fix are at best a scam or at worst, illegal. No one can legally remove accurate and timely negative information from a credit report. Rebuilding credit can be one of the most difficult aspects of personal finance as it takes time, a conscious effort, and sticking to a debt repayment plan.
When debts cannot be repaid, bankruptcy can provide a fresh start for personal finance by liquidating assets to pay debts or creating a payment plan. Bankruptcy begins when the debtor files a petition with the bankruptcy court. Individuals may file Chapter 7 or Chapter 13 bankruptcy, depending on the specifics of their case. Individuals can file bankruptcy without the assistance of a lawyer, which is called filing pro se, but getting the advice of a qualified lawyer is strongly recommended because bankruptcy has serious long term legal and financial consequences. Bankruptcy remains on a credit report for up to ten years and makes it difficult to obtain credit, purchase a car, buy or rent a home, get insurance, or even a job.
Chapter 7 bankruptcy is known as a liquidation bankruptcy. An administrator or trustee is appointed to sell the assets of the debtor, other than certain exempted necessities such as a primary residence, car, clothing, home furnishings and work tools. Once assets are liquidated, the trustee distributes the proceeds to creditors and in exchange, many debts such as credit cards and medical bills are forgiven. Other debts, such as mortgages, student loans, taxes, alimony and child support, are typically not erased.
A Chapter 13 bankruptcy is known as a reorganization. Debtors with steady income are allowed to keep property that would be liquidated in a Chapter 7 bankruptcy in exchange for agreeing to use future income to repay creditors over a three-to-five year period.
Identity theft continues to be a threat to effective personal finance management. A recent FTC report cited identity theft as the number one consumer complaint of 2014, putting it at the top of the list for the 15th consecutive year. Identity theft takes many forms including credit card fraud, misuse of government documents and records, and filing of fraudulent tax returns to claim refunds.
The consequences of identity theft can be devastating. Some victims have reported everything from funds being withdrawn from bank and financial accounts, to thieves running up vast debts and committing crimes while using the victim's name. In many cases, identity theft victims suffer out-of-pocket financial losses and incur substantial additional costs trying to restore reputations and correct erroneous information.
There are some simple precautions that can be taken to reduce the risk of falling victim to identity theft. Because so many identity theft scams are perpetrated online, any emails asking for personal information should be treated with caution. Anti-virus and anti-spyware software should be kept up-to-date and only secure web pages should be used for online shopping. Offline, investing in a shredder for destroy private records such as credit card statements, receipts, loan offers, and other documents that contain private information can reduce the risk of sensitive information falling into the wrong hands. Social security numbers should never be given out unnecessarily. Credit reports should be reviewed for suspicious activity at least annually.
Many consumers downplay the benefits of coupon clipping and bargain shopping for personal finance, but these cost-saving tactics saved American consumers an estimated $3.6 billion on consumer packaged goods in 2014. The average family can save between $500 and $1000 per year by incorporating coupons into online and in-store purchases. Even as the use of paper coupons has waned, mobile and internet coupons have steadily gained in popularity. If you have a web-enabled mobile device, you can now use it to increase your savings on everything from groceries and household products to electronics and home improvement supplies.
Wills & Estate Planning
The term estate planning encompasses the accumulation, conservation, and distribution of an estate and should be considered in any personal finance system. The most basic legal instrument of all estate plans is a will, the legal instrument whereby a person disposes of his or her property after death. Many people do not realize that even if they have not created an estate plan and executed a will, a plan has been created and imposed upon them by the state in which they reside. Each state has a statutory plan that lays out the way in which property will be distributed when a person dies without a valid will. These statutes are called intestate-succession statutes and are generally based on spousal relationships and degrees of blood relationship rather than the intention and desires of the deceased individual.
Bitcoin is a digital store of value and payment system that was invented by Satoshi Nakamoto in 2008 and made available to the public in 2009. Bitcoin is a peer-to-peer payment system that does not require an intermediary (such as a bank, credit card merchant or PayPal). Bitcoin makes it possible to transfer value anywhere very easily, but such ease of use come with security concerns. Knowing how to secure a Bitcoin wallet is essential for anyone looking to get into this rapidly expanding system. Including bitcoin in a personal finance plan also includes recognizing the potential for volatility of the bitcoin market. Bitcoin trading can produce large swings in the dollar equivalent of one Bitcoin, so users should never convert money they cannot afford to lose into Bitcoin.