Personal finance is the financial management that an individual or a family unit performs to budget, save, and spend monetary resources in a controlled manner, taking into account various financial risks and future life events.
When planning personal finances, the individual would take into account the suitability of various banking products (checking accounts, savings accounts, credit cards, and loans), insurance products (health insurance, disability insurance, life insurance, etc.), and investment products (bonds, stocks, real estate, etc.), as well as participation in monitoring and management of credit scores, income taxes, retirement funds and pensions.
History Before a specialty in personal finance was developed, various closely related disciplines, such as family economics and consumer economics, were taught in various colleges as part of home economics for over 100 years.
In 1920, Hazel Kyrk's dissertation at the University of Chicago was instrumental in developing the disciplines of consumer and family economics. Margaret Reid, a professor of home economics at the same university, is recognized as one of the pioneers in the study of consumer behavior and household behavior.
In 1947, Herbert A. Simon, a Nobel laureate, suggested that a decision-maker did not always make the best financial decision because of limited educational resources and personal inclinations.
Research into personal finance is based on several theories, such as social exchange theory and andragogy (adult learning theory). In America, professional bodies such as the American Association of Family and Consumer Sciences and the American Council on Consumer Interests started to play an important role in developing this field from the 1950s to the 1970s. The Association for Financial Counseling and Planning Education (AFCPE) at Iowa State University and the Academy of Financial Services (AFS) were established in 1984 and 1985 respectively. AFCPE started to offer several certifications for professionals in this field, such as Accredited Financial Counselor (AFC) and Certified Housing Counselor (CHC). Meanwhile, AFS cooperates with Certified Financial Planner (CFP Board).
Before 1990, the study of personal finance received little attention from mainstream economists and business faculties. However, several American universities such as Brigham Young University, Iowa State University, and San Francisco State University started to offer financial educational programs in both undergraduate and graduate programs since the 1990s. These institutions published several works in journals such as The Journal of Financial Counseling and Planning and the Journal of Personal Finance.
As the concerns about consumers' financial capability increased during the early 2000s, various education programs emerged, catering to a broad audience or a specific group of people, such as youth and women. The educational programs are frequently known as "financial literacy". However, there was no standardized curriculum for personal finance education until after the 2008 financial crisis. The United States President's Advisory Council on Financial Capability was set up in 2008 to encourage financial literacy among the American people. It also stressed the importance of developing a standard in financial education.
Personal finance principles
It is hard to define universal personal finance principles because:
Individual situations vary significantly when it comes to income, wealth, and consumption requirements. Tax and financial regulations vary between countries. Market conditions change both geographically and over time.
A financial advisor can offer personalized advice in complicated situations and for high-wealth individuals. Still, University of Chicago professor Harold Pollack and personal finance writer Helaine Olen argue that in the United States, good personal finance advice boils down to a few simple points: Pay off credit card balances every month in full Dedicate 10-20% of post-tax income for savings and investments Create an emergency fund that can last at least 6 months Maximize contributions to tax-advantaged funds such as a 401(k) retirement funds, individual retirement accounts, and 529 education savings plans When investing savings: Avoid trading individual securities Look for low-cost, diversified mutual funds that balance risk vs. reward appropriately to an individual's target retirement year If using a financial advisor, require them to commit to a fiduciary duty to act in an individual's best interest
The limits stated by laws may be different in each country; in any case personal finance should not disregard correct behavioral principles and the diligence of a "good family father": people should not develop attachment to the idea of money, morally reprehensible, and, when investing, should maintain the medium-long-term horizon avoiding hazards in the expected return of investment.
Personal financial planning process
The key component of personal finance is financial planning which is a dynamic process requiring regular monitoring and re-evaluation. In general, it involves five steps: Assessment: A person's financial situation is assessed by compiling simplified versions of financial statements, including balance sheets and income statements. A personal balance sheet lists the values of personal assets (e.g., car, house, clothes, stocks, bank account, cryptocurrencies), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statement lists personal income and expenses. Goal setting: Multiple goals are expected, including short- and long-term goals. For example, a long-term goal would be to "retire at age 65 with a personal net worth of $1,000,000", while a short-term goal would be to "save up for a new computer in the next month." Setting financial goals helps to direct financial planning by determining the parameters and expectations one aims to achieve. Plan creation: The financial plan details how to accomplish the financial goals set in the previous step. It could include, for example, reducing unnecessary expenses, increasing employment income, or investing in a fixed deposit. Execution: Execution of a financial plan often requires discipline, perseverance and sacrifice. Many people take assistance from professionals such as accountants, financial planners, investment advisers, and lawyers. Monitoring and reassessment: The financial plan is monitored in regular intervals to determine if one is on track to reach one's goals. This information is evaluated to make potential adjustments as time passes and circumstances change.
Typical goals that most adults and young adults have are paying off credit card/student loan/housing/car loan debt, investing for retirement, investing for college costs for children, and paying medical expenses.
Goals for personal finance In the modern world, there is a growing need for people to understand and take control of their finances for the following reasons:
1. Lack of comprehensive formal education: Although many countries provide some formal education in personal finance, studies by the Organisation for Economic Co-operation and Development (OECD) show low financial literacy in areas where it is not required, even in developed countries such as Japan.
Personal finance education is not always required in public education, with just under 30% of high schools in the US in 2024 not requiring personal finance for graduation. Graduates with financial education have higher average credit scores and receive more favorable loan conditions. Hence, it is essential to recognize the connection between financial courses in the education system and the generational shift in personal financial education.
This illustrates the importance of learning personal finance from an early stage, differentiating between needs and wants, improving financial literacy, and building financial planning skills.
2. Shortened employable age: Over the years, with the advent of automation and changing needs, several jobs that require manual intervention or involve mechanical tasks have increasingly become redundant worldwide.
Several employment opportunities are shifting from countries with higher labor costs to countries with lower labor costs, allowing companies to keep costs low. In economies with a considerably large younger population entering the workforce and better equipped with the latest technologies, employees in middle management who have not upskilled may be replaced by newer employees who cost organizations less. Cyclical nature of several industries: In industries such as automobiles, chemicals, and construction, consumption and demand are driven by the health of a country's economy. When economies stagnate, enter recession, or experience war, specific industries may suffer more than others. This can result in companies reducing their workforce. An individual can lose their job quickly and remain unemployed for a considerable period. These factors suggest that the effective employable age may be gradually decreasing.
These are some of the reasons individuals should start planning for retirement and systematically build their retirement corpus, hence the need for personal finance.
3. Increased life expectancy: With developments in healthcare, people today live to an older age than previous generations. Average life expectancy has increased even in developing economies. It has gradually risen from 60 to 81 years and above, which, coupled with a shorter employable age, reinforces the need for a sufficiently large retirement corpus and the importance of personal finance.
4. Rising medical expenses: Medical expenses, including the costs of prescription medicine, hospital care, nursing care, specialized care, and geriatric care, have risen over the years. Many of these expenses are not covered by private or individual insurance policies or by federal or national insurance programs.
In developed markets such as the US, insurance coverage is provided by employers, private insurers, or the federal government through Medicare, primarily for senior citizens, or Medicaid, primarily for individuals with lower incomes. However, given the rising US fiscal deficit and the large proportion of senior citizens, the long-term sustainability of the Medicare program remains uncertain. Therapy exclusions, copayments, deductibles, and other costs may have to be borne by individuals. In other developed markets, such as the EU, most medical care is nationally reimbursed. This leads to national healthcare budgets being tightly controlled. Many newer and expensive therapies are excluded from national formularies. This means that patients may not have access to them through government programs and may have to pay out of pocket for these medicines. In developing countries such as India and China, most expenses are paid out of pocket, as there is no overarching government social security system covering medical expenses.
These reasons illustrate the need to have medical, accident, critical illness, and life insurance coverage for oneself and one's family, as well as an emergency corpus.
Areas of focus Critical areas of personal financial planning, as suggested by the Financial Planning Standards Board, are: Financial position: Financial position is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all household liabilities, at one point. Household cash flow is the total of all the expected income sources within a year minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and when the personal goals can be accomplished.