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LAST UPDATED: FEBRUARY 15, 2024

Importance of Personal Financial Management

    Personal finance is nothing but financial transactions related to an Individual. In this article, I will try to define personal finance and its importance in very simple language. Let's start with understanding what exactly is a part of personal finance.

    What is Personal Finance?

    Personal Finance is defined as the management of one's own money which includes the financial decisions for a person or a family. It is as simple as that.

    There are four main components of Personal Finance:

    1. Cash Inflows/Income

    2. Cash outflows/expenses

    3. Savings

    4. Investments

    Now the question arises what is personal financial management?

    Personal Financial Management

    So personal financial management is nothing but managing the components of personal finance in such a way that we can achieve our future goals and minimize various financial risks associated with an individual.

    With this, another question arises, which is, why should we learn about personal financial management?

    A clear answer to this question would be, that if you don't know how to manage your personal finances, no matter how much you earn you can never be rich (easily).

    Secondly in today's world, if you want to enjoy life then you have to minimize your financial risks, which can only be done by learning personal finance.

    Now how can you start your Financial management?

    The first thing should be setting targets, like how much you are going to need for one of your future goals like buying a car, buying a house, marriage, international holidays, children's education, retirement corpus, etc., and how much time you have for that.

    Secondly, you need to define the financial risks which may arise in the future as everything is so uncertain these days. This may include loss of job, medical expenses as a result of any major disease, or the financial burden your family might have to face in case you die.

    So how and what components of personal finance can we use to achieve the above goals and minimize future risks?

    To achieve our future goals we can use components of savings and investments. There are different kinds of savings and investment instruments which you can choose according to your future goals and risk appetite, as there is always a risk involved in any kind of investment. If you want higher returns on your investments then you have to go for investment instruments that involve greater risk. In case you do not have deep knowledge about investment instruments, you can always consult a financial adviser for your investment needs.

    If you have a fixed income then managing your cash outflow is also very important. My favorite saying is:

    "If you buy things you do not need, soon you will have to sell things you need"

    by Warren Buffet.

    Now let's talk about these investment instruments we can use to minimize the future risks associated with an individual.

    This can be done by having a contingency fund, Mediclaim policy, and Term Insurance.

    What is a Contingency Fund?

    Let's suppose you have a fixed monthly income of Rs. 50000/-.

    The contingency fund will be a fund worth Rs. N * 50000 where N can be 6 to 12 depending upon your convenience.

    A contingency fund comes in handy in case of job loss or termination of fixed income due to any other reason. It gives you a cushion period to start a new income source.

    Mediclaim Policy

    Medicaliam policy is a very crucial risk minimization instrument. In my opinion, every individual who earns a fixed income should have a Mediclaim policy so that your medical bills won't make a hole in your pocket.

    Mediclaim policy is a simple insurance policy where you pay a certain amount of premium every year (which is a very nominal amount) and all your medical expenses will be borne by the insurance company in case of hospitalization due to any reason. You can get a policy like this from policybazaar.com or from any other insurance company of your choice.

    Term Plan

    A term plan is an insurance plan where you pay a certain amount of premium every year depending upon your age and health condition in return of a sum assured (generally 10-20 times of your annual income) to your family in case of your demise due to any reason.

    While understanding the basics of term life insurance is crucial, choosing the right policy among various term life insurance options can significantly impact your financial protection strategy. For a comprehensive comparison and insights, explore our detailed reviews on term life insurance options (USA). This resource is designed to help you navigate the complexities of term life insurance, ensuring you make a choice that best suits your needs and provides peace of mind.

    In India, there are many websites like PolicyBazar, where you can find different term plans easily.

    Mutual Funds

    Mutual funds are a great way of investing money in a country like India, where Mutual funds pay a good annual return of about 15% (average), which is a great way to keep your savings growing. It is safer than investing money in Stock market, as the risk involved is less, and generally, Mutual funds are handled by experienced teams, so you don't have to worry about picking stocks by yourself, which requires a lot of stock market analysis.

    In India, Apps like Groww, Zerodha(Kite), or ETMoney are a great way to invest money in just a few clicks.

    Conclusion

    Apart from these options, you can also invest in Mutual Funds, but that would require a separate article altogether, which I will soon publish.

    So you see how by putting a little time and energy into managing your personal finances, you can make your life so much less stressful and invest this precious time and energy in things you love.

    I am a mechanical engineer. I belive that everybody should learn physics because only physics tells you how everything around you works.
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