What is personal finance?

Personal finance is all about how individuals and families manage, save, and invest their money. It involves budgeting, saving for the future, and planning for retirement.

On this page, we explore the basics of personal finance and why it matters. We also look at how you can manage your money effectively to reach your financial goals.

Personal finance is the process of planning and managing your financial activities - whether for yourself or your family. It involves making decisions about how you generate income, how you spend and save that income, how you invest it, and how you protect it. Examples of personal finance include budgeting and insurance, mortgage planning, savings, and retirement planning - in fact, it influences every aspect of your financial life.

Managing personal finances means mapping out a clear path for your financial journey. This is typically set out in a budget or financial plan. A personal financial plan gives some structure to your finances, helping you use your income to achieve financial stability and meet your long-term goals.

The definition of personal finance is not just about individual money management, it can also refer to the broader financial services industry. This includes personal finance guidance on financial and investment options. Services in this area are also provided by financial planners, investment advisers, tax advisers, and mortgage brokers.

A common question many people have is, “What is personal finance and why is it important for my future?” Understanding personal finance principles gives you the knowledge and tools to manage your money effectively and lays the foundation for future financial success. Indeed, many people believe the basics of personal finance should be taught in schools, because they can be a useful life skill.

Taking charge of your finances as part of a personal finance plan can help you keep track of where and how you’re spending your money. This not only helps you stay within your budget, but also puts you in a better position to save. For example, by tracking your expenses, you might discover you’re spending too much on eating out and then switch to using that money for debt repayment or savings.

Personal finance goes beyond tracking spending; the financial planning process can help to increase your financial independence by enabling you to make informed decisions. A carefully considered personal financial plan can give you the confidence to handle unexpected costs and life changes with ease. Perhaps most importantly, knowing how to manage your finances gives you the skills to compare savings and bank accounts and decide where to invest your money.

Whether you’re deciding on the best approach to saving and spending, comparing costs before a big purchase, or planning for retirement, personal money management skills can help you to achieve both short-term goals and long-term dreams.

Personal finance is the overarching term for several different aspects of someone’s financial situation. It is often categorised into five main areas: income, saving, spending, investing, and protection.

Income forms the foundation of personal financial planning. When considering your own income, you could take into account earnings from employment, business, investments, pensions, and dividends. Understanding and maximising your income is a key aspect of your personal finances, and gives you clarity on what you have coming in each month.

Saving involves setting aside money for future needs and emergencies. It includes banking services like current and savings accounts, as well as any cash savings you might have. It’s not something you do once; developing a consistent savings habit is important for long-term financial security.

Furthermore, it's important not to leave your money idling in a low-interest account. Exploring alternative accounts beyond traditional high-street banks can help ensure you’re getting the best possible interest rates.

Managing your spending is essential to ensure you are living within your means. This includes everyday expenses as well as larger financial commitments like loans and credit card payments. Household finances should also be taken into account if you share expenses with others.

Investing is about growing your wealth through options such as bonds, stocks, and real estate is key to financial growth. Investing offers the potential to grow your funds, but it also carries real risks, including potential loss of capital.

Here are just a few forms of investing:

• Stocks
• Bonds
• Property
• Mutual funds
• Money market funds

Safeguarding your finances involves having adequate insurance plans, including health, disability, and life insurance. It also covers protective measures like maintaining a good credit score and planning for income taxes, retirement savings, and pensions.

By focusing on these five core components, the idea is that you can build a solid foundation for managing your finances effectively.

Now that we’ve discussed the meaning of personal finance, we can look at different steps in the personal money management process. This process is generally summarised within a budget or financial plan.

While the personal finance planning process will look different from one person to the next, we’ve listed some key elements that often form a financial plan:

1. Assess your financial situation: You could start by working out where you currently stand financially. This involves adding up all your assets (like savings, investments, and property) and subtracting any debts (like loans or credit card balances). This gives you a clear picture of your financial health.
2. Set financial goals: Define your short-term and long-term financial objectives. Whether it's saving for a mortgage, planning for retirement, or paying off debt, having clear goals will guide your financial decisions. If savings is your priority, you can find out more on our savings goals page.
3. Manage debt: Develop a plan to tackle any outstanding debts. This could be prioritised if you have high-interest debt that is cancelling out any savings interest. You might also consider debt consolidation or restructuring if it helps streamline repayments.
4. Create a budget: Develop a budget that outlines your monthly income and expenses. By tracking your spending, you might be able to identify areas where you can save or cut back. Consider using the 50/30/20 rule for a structured approach to budgeting.
5. Plan for retirement: It’s generally recommended to start saving for retirement as soon as you can. You might look into contributing to a workplace pension scheme or setting up a personal pension plan, while taking advantage of any employer contributions.
6. Build emergency funds: This involves setting aside funds to cover any unexpected expenses, such as sudden unemployment or car repairs. Experts suggest aiming to have enough saved to cover living expenses for three to six months. Consider putting this money in a savings account that you can access easily.
   Once you’ve built your emergency fund, you might look at locking further savings away in a fixed rate bond. In return for not having access to your funds for a set time, you generally benefit from higher interest rates.
7. Get insurance coverage: This includes health insurance, life insurance, and income protection insurance for yourself and your family. You could review your insurance coverage from time to time to make sure it still meets your needs.
8. Create an estate plan: Ensure your financial assets are protected and distributed according to your wishes in the event of your death. This might involve drafting a will and setting up trusts if needed. You might also appoint a power of attorney to make decisions on your behalf if you become unable to do so yourself, due to illness or incapacity.
9. Regularly review and adjust your plan: Periodically revisit your personal financial plan to check that it’s still in line with your goals and circumstances. You might need to make adjustments based on changes in income or expenses.

While the basics of personal finance might seem achievable on paper, they won’t be suitable for everyone. It might help to get in touch with an adviser who can provide tailored personal finance advice and guidance.

There are various personal finance services available to meet specific needs, including the following:

• Wealth managers: Help manage your investments and personal financial planning.
• Lending and debt services: Assistance with loans and managing debt effectively.
• Retirement planning: Guidance on saving and investing for retirement.
• Tax advisers: Tax planning and advice.
• Risk managers: Strategies to reduce financial risks.
• Estate planners: Assist with estate planning and inheritance matters.
• Investment advisers: Offer advice on investment options.
• Insurance services: Assistance with selecting and managing insurance policies.
• Mortgage brokers: Services related to mortgage management.

For more information on choosing a financial adviser, Citizens Advice offers guidance.

These services, along with personal finance in general, become especially important when you begin your first job. However, students can also benefit from managing their finances and budgeting early on. The first step in managing your personal finances could be something as simple as downloading a money-saving app to track expenses.

While investing or planning for retirement might not be at the top of your priorities now, developing money management skills can be invaluable for the future.

The 50/30/20 rule is a popular and easy-to-follow budgeting method. This rule helps you allocate your monthly income into three categories:

• 50% for needs: This portion covers essential expenses such as rent or mortgage, bills, and food.
• 30% for wants: This segment is for non-essential spending on items like eating out, entertainment, and shopping.
• 20% for savings and debt repayment: This includes contributions to savings accounts, retirement funds, and debt payments.

The advantage of this approach is that 20% of your monthly income goes towards managing your finances, whether that’s savings or paying off debts.

Of course, your situation may require you to put more money towards unavoidable expenses like rent and energy bills. You can easily adjust the percentages to suit your needs; for example, a 70/20/10 ratio might work better for you.

The key idea in personal finance is not to spend more than you earn or take on more debt than you can reasonably pay back. Sticking to some form of budget, however you break it down, can help you stay within your means.

Managing personal finances can be challenging. Here are some common issues people face:

• Monthly spending exceeds income: One of the most frequent issues is when individuals consistently spend more than they earn each month, leading to increased debt and financial stress.

• Lack of a financial cushion: Without an emergency fund, unexpected expenses can cause significant financial strain and lead to debt.

• Carrying a credit card balance: High-interest credit card debt is a common problem that can quickly spiral out of control if not managed properly.

• Inadequate retirement savings: Not saving enough for a retirement nest egg can lead to financial insecurity later on.

• Rising rent costs: Increasing rent can make it difficult to stick to a budget and save money.

Your personal finances are likely to change as you get older or your life circumstances evolve. For example, investing may make more sense when you’re younger and have more time to recover from potential losses. In contrast, someone approaching retirement age might avoid risking sums of money they will need in their later years.

This is why it can be a good idea to revisit and adjust your personal financial plan every so often. While you can’t predict every expense that comes your way, staying aware of your financial health can help. Regularly reviewing your savings can be particularly effective, since your earnings can fluctuate due to factors like inflation and interest rates.

A high-interest savings account is a key tool in personal finance, allowing your savings to grow faster over time. A high-interest savings account can help you reach your goals more quickly. Consider registering for an account on Raisin UK to explore options that can help you get the most from your savings.