Personal financial management is an essential economic concept that is not emphasized enough in our society. This is one of the main reasons why many people end up facing financial difficulties. Lack of personal financial management skills results in bad financial habits that make people indebted beyond their means. As a result, people end up piling debt and damaging their credit report.
Good personal financial management skills are therefore absolutely vital in this day and age. Ideally, children should be taught these skills right from a very young age. So that they can develop and cultivate good personal financial management habits. Thus, as they grow into adults, they can responsibly manage their finances.
Personal financial management comprises of multiple elements, namely.
These are the four main elements of personal financial management that must be acted upon simultaneously to stay on course to achieve your financial goals.
Saving is one of the most important elements of personal financial management. The rate of savings and the spending rate can determine the time it takes to achieve financial savings goals. However, one very important factor that determines the rate of savings and the whole financial strategy for any individual is the savings goal or target.
Goal setting is a crucial concept in shaping the financial strategy for any individual or even an organization or country. If you look at corporate management strategies, it will become clear just how important concepts such as mission statement, corporate objectives, and strategies are. Without these, the company cannot achieve the periodic, short term, and long term targets.
The same principle applies to individuals. To have a viable financial strategy, one needs to have clear and well defined financial and savings goals. Goals allow individuals to direct their focus and attention productively and efficiently.
Behavioral sciences have proven that human beings work well with well-defined goals, strategies, and objectives. A person without short and long-term goals would not have any direction towards which to work and would soon lose motivation and the passion to work.
Goal setting is thus a core principle of personal financial management. When it comes to savings, the goal-setting should be divided into long and short term savings goals.
Long and Short term goals
Individuals can have different long term goals based on personal circumstances. Most people have a personal long-term goal of saving up enough for their retirement. While some people, known better as FIRE enthusiasts, have the long term goal of financial independence.
The long term goals are then supplemented by short term goals, which are attained along the way to completing long-term goals. It is also possible for individuals to have multiple long term goals.
For instance, a person may have the primary long term aim of saving $2 million for their retirement. In addition to this goal, they may also have another goal of buying a house and paying off the mortgage before retirement.
Similarly, short term goals may include owning a car, going on holidays, or annual saving targets. The list can be very long, but right now, it is enough to mention that any individual is going to have both multiple long term and short term goals simultaneously.
It is perfectly okay to have multiple long and short-term goals. What is wrong, however, is the absence of a strategy to attain those goals. Many people go well into their mid-life without having any sort of strategy to attain their financial goals. Doing so is extremely naive, as formulating any financial strategy after the age of 40 becomes very difficult.
This is why, as was mentioned earlier. The ideal time to start teaching someone about personal financial management is right when they are an infant. Because if we teach personal financial management from this early age, by the time that child turns 18, they will have a clear idea of what they need to do in their life. Even if such an individual takes the next decade formulating the long and short-term goals, they will not be in trouble as they will have enough time to plan and execute those plans.
The best time for setting your long and short-term financial goals is in your twenties. Some people may set their goals as early as late teens, but it has been generally observed that the goals set in the twenties are based on a more realistic approach.
The problem with setting goals in the late teens is that by the time an individual is in their late teens, they are neither educationally nor mentally mature enough to make long-lasting decisions.
However, add a few more years of work, relationships, and practical experience, and thus by the time a person hits through the mid-twenties, they are a completely different person in terms of their outlook on life.
In simple words, the 20-30 age group is the right time to formalize your life’s long and short term goals. To be more specific, it is best if this can be done between 20-25, and if one takes it to 30 years of age, then that would be fine, but it would be pushing the luck. Why? Because every year after the age of 25 is extremely precious. The more time you waste, the harder you will have to work to achieve your goals.
25 is, therefore, the optimum age to get your priorities sorted and start working towards your long and short-term goals.
Assuming that the age of retirement is 65 years if a person gets their priorities right at the age of 25, this would give them a good 40 years to attain their goals. Four decades is a lot of time, which can be further broken down into periods of 10 years, five years, and then annual targets.
If your end goal is to save up $2 million, you need to break it down into smaller, more achievable chunks. Nobody climbed Everest simply by looking at its peak. Every small step matters to climb that summit. The same is true for financial goals and stability. Every penny counts towards the end goal of $2 million.
If we make our goal of $2 million savings, this can be broken down to an annual savings target of $50,000, which can be further broken down into a monthly savings target of roughly $4200.
Saving $4200 does not sound as difficult as saving $2 million, now does it?
As discussed above, the best option is to break down the long term goals into short term loans divided over ten, five, and annual periods.
The following periods can serve as important milestones.
This seven-year period is the most important in the life of any individual. We have already discussed this in-depth in the previous section. This is the formative period when an individual sets their career in motion. Usually, by the age of 25, individuals are well settled into their careers, thus thinking with a clear mind about their future.
This is also a very careless time for anyone, and for this reason, many people do not focus a lot on saving. Still, good personal financial management habits require one to be prudent right from the starting.
We cannot set a limit at this point, but the more savings one can have, the better. It is certainly easier to save when one is young and not committed to long term relationships. The expenses are low, and at this stage, it is easier to mold the behavior and change the lifestyle to cut down the expenses. Usually, individuals during this period in life do not commit to banking, investing, mortgage, and insurance. Low commitments make this period of life the best time to start saving money for the future.
This is also the best time to get life insurance and slowly start investing your savings in creating portfolio income. At this stage, it would be best to invest in extremely low-risk investment options, such as index funds, low-risk bonds, and ETFs. Create an emergency fund for personal financial management. One can also invest in shares only if the investors have the required knowledge of the market.
Savings account used to be a good option, but interest rates are globally at their lowest, and thus there is no longer any point in keeping money in a savings account. Savings accounts are only good when the rate they offer is better than the rate of inflation.
This is the period when you are required to be completely focused on your work. People also tend to get into long-term relationships during this period, which is why typically, the two decades following the age of 25 can see increased expenditure in wedding expenses, holidays, mortgage, insurance, student loan repayment, and expenditure on a family. This must be accounted for, and the budget should be maintained so that the savings continue to accumulate without any hindrance to attain the long term financial goals on time.
By the age of 35, a person should ideally have $200,000 to $500,000 if they intend to save over $2 million for their retirement. It must be remembered that savings do not accumulate uniformly. For instance, if the goal is to save $2 million, you will not save $50,000 per annum.
The savings rate, in the beginning, will be lower than this. What makes the difference is the exponential returns that start generating after a decade or two of savings. However, to generate exponential returns, one needs to have a proper wealth generation strategy in place.
For this, the savings need to be invested in profitable investment options. This requires taking on a bit of risk as well.
It is common for individuals at this stage to have 401(K) accounts. However, banking on the 401(K) alone is not going to get you through. You need to generate passive and portfolio income streams to supplement your active income. In addition to this, you also need to set up an emergency fund to meet any financial emergency and prevent it from eating up the long term savings.
These twenty years are very important for everyone. If by this time you do not have a financial strategy and savings goals to work towards, it may be too late, but then again, it is never too late for those who already have a strategy and are working towards it. These twenty years are important because, during this time, the strategies will need to be tweaked.
People get married, their expenditures increase, and many get medical conditions that require constant treatment. These factors add a strain on the budget, but if you have successfully created multiple income streams, you have prepared your portfolio to absorb the financial strain.
These twenty years are also critical from the wealth creation point of view. People who set wealth creation as their long term goal usually start getting exponential returns around this time.
Once a person hits the 50-year mark, they should also reassess their financial strategy because the expenditure pattern in the last 10-15 years of one’s working life closely reflects the post-retirement expenditure. The withdrawal rate at this point can help adjust the final target in a better manner. For instance, a person saves up $2 million by the age of 65, and they are expected to live 30 more years, which translates into roughly $5555 expenditure per month.
This withdrawal rate can be compared with other expenditures and the current monthly expenses to determine whether you are on track to meet your target or not. The portfolio will be well-balanced at this stage, allowing exponential returns while keeping the risk at a minimal level.
The last ten years up to retirement are perhaps the easiest in terms of financial strategy and planning. People are well settled into their spending patterns. They have got their priorities set and goals in sight. Their savings are growing at an exponential rate. The only thing they need to keep in mind are tweaks to their strategy to stay on track.
By the time you reach the age of retirement, you should have attained most of your short and long term goals. Of course, it is common for the goals to be set back. For instance, the 2008 financial crisis had a very negative impact on retirement savings and, in some cases, forced people to push their retirement by as much as ten years.
One should be prepared for such external shocks. The current Covid-19 induced financial crisis is doing the same to many individuals across the globe. A person can try to be prepared, but when such financial disasters strike the global economy, very little can do.
Nevertheless, by setting short and long-term savings goals, individuals can, to a very great extent, bring financial discipline to their lives, rise above financial stress, and live a life defined by purpose and passion.