Byline: Nazir Ahmed Shaikh
"Financial peace isn't the acquisition of stuff. It's learning to live on less than you make, so you can give money back and have money to invest. You can't win until you do this." - Dave Ramsey
Finance is always of great importance, be it in a business or in one's everyday life. As it is important to manage risks in business, it is equally important to manage risks in life as well. The Banking and Finance Glossary, published jointly by SBP and IBP, define the Personal Finance as financial arrangements of the individuals or households concerning savings, deposits, installment loans or credit card facilities, lines of credits or overdraft allowed on bank accounts. The management of personal finance based on income profile, earning capacity, age, current expenses and obligations and other relevant factors; retail financial facilities provided to individuals and household by financial institutions. In simple words, Personal Finance is the management of money and financial decisions for a person or family including budgeting, investments, retirement planning.
A common scenario at home to sit down with spouse and plan out spending for loan adjustments or children's school fees. To decide to whether go out for dinner or stay back and save money by cooking at home.
To have a better understanding of Personal Finance in standard or conventional banking system as well as Islamic Banking; let's have a closer look to both systems.
Component of personal finance
Components of personal finance might include checking and savings accounts, credit cards and consumer loans, investments in the stock market, retirement plans, social security benefits, insurance policies, and income tax management.
* Financial Position: The net worth (i.e. household assets minus household liabilities); and household cash flow (i.e. expected yearly income minus expected yearly expenses).
* Security: Protection of household in event of an emergency; for example death.
* Tax Planning: Lowering tax costs through tax reduction measures.
* Investment: Investing for financial goals; For example it is for a new house.
* Retirement Planning: Planning for future to be financially secure enough, at the time of retirement.
* Estate Planning: Planning for what will happen when you die, and planning for the tax due to the government at that time.
So, the personal finance is knowing how to budget, balance a checkbook, obtain funds for major purchases, save for retirement, plans for taxes, purchase insurance and make investments.
Personal finance planning process
As with any type of planning, Personal Finance management comes down to having a solid plan. All of the above areas of personal finance can be wrapped into formal financial plan. Commonly, these plans are prepared by personal bankers and investment advisors who work with their clients to understand their needs and goals and develop an appropriate course of action
Generally speaking, the main components of the financial planning process are: Assessment, Goals, Plan Development, Execution and Monitoring and Reassessment.
Personal finance span
As shown in the illustration (Figure #1), the main areas of personal finance are income, expenditure, saving, investments and security.
Income: The starting point for personal finance roadmap is income. It is the source of cash in-flow that an individual can use to either spend, save or invest. Common sources of income are: Monthly Salary / Hourly or weekly Wages; Bonus; Pension; and Dividends/Profit on shares.
Expenditure: Expenditure or spending includes all types of expenses an individual incurs related to buying goods or services or anything that is consumable (i.e., not an investment). All spending falls into two categories: cash (paid for with cash on hand) and credit (paid for by borrowing money). The majority of most people's income is allocated to spending.
Common sources of spending are: Food, Rent, Entertainment, Taxes, Credit Card Payments, Mortgage Loan Re-payments/Adjustments and Travel.
All these expenses reduces the amount of cash an individual has available for saving and/or investing. Good spending habits are vital for good personal finance management. If expenses are greater than income, the individual has a deficit. Managing expenses is just as important as generating income. Typically people have more control over their discretionary expenses than their income.
Saving: Saving refers to the surplus amount between the earnings as income and spending. The difference can be directed towards savings or investments. Managing savings is a critical area of personal finance.
Common forms of savings include: Physical cash, Savings bank account and Money market securities.
Normally people keep at least some savings to manage their cash flow and the short-term difference between their income and expenses. Large amount of savings is not advisable as it earns little or no return compared to investments.
Investment: It is relates to the purchase of assets that are expected to receive back more money than originally invested, over a period of time. However. Investing carries risk, as not all assets actually end up producing a positive rate of return.
Common forms of investing include: Stocks, Bonds, Mutual funds, Real estate, Private companies and Commodities.
Investing is the most complicated area of personal finance. There are vast differences in risk and rewards between different investments. Most people seek advice with this area of their financial plan.
Security: Personal Security refers to a wide range of products that can be used to guard against an unforeseen and adverse event.
Common protection products include: Life insurance, Health insurance and Real state.
This is another area of personal finance where people typically seek professional advice. There is a whole series of analysis that needs to be done to properly assess an individual's insurance and/or real state planning needs.
Conventional banking system
To have a better understanding of Personal Finance in standard or conventional banking system as well as Islamic...