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What are personal finance skills and how do they work?

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What are personal finance skills and how do they work?

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Personal finance skills are strategies and habits that can help you manage your finances more effectively. Picking up these skills is essential for every ‘grownup’ because it can help achieve financial independence and stability. 

That said, you may be wondering how to improve your finance skills. If that’s the case, here’s some great news for you. The first step to acquiring and honing the personal financial skills necessary for a stable future is to learn more about what they are and how they work. 

What are some key personal finance skills that you should learn? 

Fortunately, learning personal finance skills isn’t as hard as it is made out to be. You don’t need any formal education to help you out either. There are plenty of simple personal finance skills that you can pick up all by yourself.

To make it easier for you to get familiar with the fundamental practices of good personal finance, I’ve grouped the key finance skills you need into different categories, as follows:

  • Saving
  • Budgeting
  • Borrowing 
  • Investing 
  • Bonus skills 

1)Saving: Personal finance skills to help you save more effectively

a. Opening your bank account

Around 190 million adults in India still don’t have their own bank account. If you belong to this category, opening a bank account for yourself is perhaps the most fundamental finance skill you should learn.

A bank account is necessary for establishing financial independence. It allows you to hold large amounts of cash safely, helps you save more easily and even provides instant access to your money. Also, you get to enjoy insurance on your bank account deposits to the tune of Rs. 5 lakhs, which is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC). And you get to earn interest on your savings. Cool, right? So, if you’re a working professional in India, open a savings account online in 3 minutes with Fi. PS. There’s zero paperwork involved!

b. Setting financial goals

Saving without a clear goal or target in mind can actually hinder your progress. That’s why it is important to learn how to set financial goals. Having a goal acts as a motivating factor and helps you focus better. That’s not all. Tracking your progress also becomes a whole lot easier. 

If you’re unsure of how to set financial goals, following the SMART guideline can help. SMART is an acronym that stands for the following attributes:

  • Specific
  • Measurable
  • Attainable
  • Relevant 
  • Time-Bound

c. Creating an emergency fund 

Seeing as life can be very unpredictable, it is important for you to be ready for all kinds of contingencies and unknown variables. Here’s where an emergency fund comes into the picture. Setting up an emergency fund is one of the best finance skills that you can learn because it helps you be financially ready to tackle the unknown. 

As a rule of thumb, your emergency corpus should contain funds equal to a minimum of at least 6 months’ worth of expenses. That said, keep in mind that the more funds in your emergency corpus, the better. Also, you should only dip into the fund during emergencies — and not cover your regular monthly expenses. 

2)Budgeting: Personal finance skills to make budgeting a breeze

a.Differentiating between needs and wants

Although they may seem similar, wants and needs are entirely different from one another. Needs are things that you absolutely require, like food, clothing, shelter, transportation and healthcare. On the other hand, wants are non-essential to your daily survival. 

Learning how to differentiate between them is a very important finance skill. Being able to identify your expenses based on wants and needs can help you make much better financial decisions. 

That said, it is not practical to completely cut off spending on things that you want. Instead, you could keep a cap on just how much you can spend on non-essential items and services. Ideally, it is advisable to restrict your spending on such things to just around 20% of your monthly income.

b.Drawing up your first budget 

Drawing up a budget is arguably the most basic finance skill that you should learn. It simply involves listing out all your sources of income and all your expenses in detail. This allows you to quickly identify where you’re overspending. It can also help you restrict unnecessary spending in a timely manner. In addition to that, a budget can also give you an idea of what to spend on, and how much money you have left to save up each month. 

There are many budgeting rules that can help you here. One of the most common strategies is the 50-30-20 rule. According to this budgeting rule —

  • 50% of your monthly income should go towards your needs
  • 30% of your monthly income should go towards your wants
    20% of your monthly income should go towards savings

Once you’ve laid out a budget along these rules, you can then proceed to adjust your spending so that it remains within these set limits. 

c.Adjusting your budget over time

Now, creating a budget isn’t a one-time process. You need to carefully monitor, evaluate and adjust your budget at periodic intervals. And considering the fact that your financial priorities tend to change over time, it is crucial to learn how to adjust your budget accordingly. 

The 50-30-20 budgeting rule may be ideal for when you’re young. However, once you start a family of your own, you should ideally revisit the rule and adjust it as needed. You may have to allocate more of your income for your needs or for your investments. This will ensure that you adequately account for added responsibilities. 

For example, you could reduce your spending on things that you want to 20% and increase the amount of savings to 30%. Doing so allows you to contribute a larger portion of your income towards saving for the future, which is very essential, especially if your family has grown to include children. 

3)Borrowing: Personal finance skills to keep you from falling into a debt trap

a.Managing your credit cards

A credit card is an excellent financial tool that can come in very handy during emergencies. However, using a credit card carelessly can quickly lead you into a debt trap. This is precisely why it is essential for you to learn the basic finance skill of managing a credit card. 

If you’re a regular user of a credit card, then make sure to pay your bills in full before the due date. Failing to do so can lead to heavy penalties and interest charges, which usually tend to be exorbitant. Also, it is a good idea to refrain from opting for a credit card loan or withdrawing cash from your card as much as possible. 

b.Building a good credit history 

When you apply for a loan or any other credit facility, there are two metrics that financial institutions value above all else — credit history and credit score. If you have a good credit history and a high credit score, you may be eligible for more attractive loan offers at lower rates of interest. 

Knowing how to build good credit history can make it easier for you to access credit facilities that you will need to achieve your financial goals. Here’s what you can do to improve your credit history —

  • Start off by applying for a credit card and using it frequently
  • Pay your loan EMIs and credit card dues on time
  • Limit your credit utilisation ratio to 30% of your credit limit
  • Have a mix of debt in your portfolio
  • Do not borrow what you cannot repay

c.Choosing the right kind of debt 

If you’re like most people, you may tend to think that debt is inherently bad. I believed this too until I did some research and understood that there are some debts that are actually good. These kinds of debts help you create assets or reduce your tax liabilities. 

For instance, a home loan is a kind of good debt. Why? Because it helps you create an asset, which in this case is a house. Apart from helping you purchase your own dream home, this kind of loan also offers tax deductions on the principal and the interest repaid. 

Knowing how to choose the right kind of debt is a crucial personal finance skill that can help you get closer to financial independence much faster.

4)Investing: Personal finance skills to invest better for your future 

a.Starting an SIP

Knowing how to start an SIP is another crucial finance skill that can be of immense help. SIP is an acronym for Systematic Investment Plan. In an SIP, you invest small amounts regularly in the asset vehicle of your choice for a specific period of time. Through an SIP, you can invest in a particular stock, a basket of your stocks, or in a mutual fund. You have the freedom to choose the amount and the tenure of investment too. 

An SIP allows you to effectively counteract the unpredictable and highly volatile nature of the stock market. And it also gives you various other benefits like the advantage of compounding and rupee cost averaging. Plus, you don’t have to worry about not having a lump sum amount to invest. 

b.Diversifying your portfolio

Portfolio diversification is investing in different assets instead of just one or two options. This can protect your portfolio from massive losses during market downturns or in a recession. And during favourable market conditions, diversification increases your chances of earning higher returns. 

For instance, you could choose to split your investment amount equally between gold, fixed deposits and the stock market. The returns from gold and fixed deposits can keep you afloat during times when the stock market is underperforming. Similarly, when gold and fixed deposit returns are at an all-time low, the returns from the stock market may compensate. 

c.Investing according to your risk profile and your goals

Not every investor has the same risk profile or the same goals. Some investors may be completely averse to risk, while others may prefer to invest in risky assets in return for possibly higher returns. 

Knowing how to invest as per your risk profile and your goals is another essential financial skill — one that can help you create wealth in the long term. 

For instance, if you’re a risk-averse investor who is planning on saving up for retirement, you could consider investing in long-term, low-risk options like fixed deposits, Public Provident Fund (PPF), and National Savings Certificate (NSC) and the like.

Bonus: Personal finance skills that are crucial for everybody

1.Understanding how insurance works

Insurance is simply a contract where you’re required to pay a certain amount of money regularly, known as premiums, to an insurance company. In return, the insurance company provides you with financial coverage for specific assets or contingencies for a specified period of time. Purchasing an insurance policy can help reduce the financial impact that untoward incidents may have on the secured asset. 

There are different kinds of insurance like the following —

  • Life Insurance
  • Health Insurance 
  • Motor Insurance
  • Home Insurance 
  • Travel Insurance 

Each kind of insurance is important, and if you’re a beginner in personal finance, it is important to understand how insurance works. With the right kind of insurance, you can secure the future of your family, shield yourself from rising medical costs and ensure that your vehicle can be repaired adequately in case of any damages without tapping into your savings.

2.Figuring out how taxes work

Although this is more of a technical finance skill, it is nevertheless crucial. Taxes, both direct and indirect, form a major part of our lives. Being aware of how they work can help you make better financial decisions.

For instance, when it comes to income tax, income is categorised into multiple different heads based on its source. That’s not all. Certain kinds of income are taxed at a higher or a lower rate, whereas a few of them are outrightly exempt from taxation. Also, there are specific investments that allow you to reduce your total taxable income, thereby helping you lower your tax outlay. 

Getting to know these aspects of income tax can help you plan your investments better, lower your tax liability and make the most of the tax benefits available in India.

3.Understanding inflation

Inflation is a phenomenon wherein the purchasing power of money reduces over time. In other words, prices of goods and services increase. The bottom line? You will have to pay more to purchase the same goods and services. The higher the inflation rate, the higher the prices of goods and services are likely to be and vice versa. 

It is important that you understand how this works, so you can plan your savings and investments smartly. When investing, you should always remember to account for inflation. It is advisable that you invest in assets that offer inflation-beating returns — or returns that are higher than the present inflation rate. This will help you stay ahead of the curve.

Conclusion

As you can see, possessing the right personal finance skills can make financial planning a whole lot easier — and even fun. Apart from giving you an idea of finance in general, these skills also ensure that you continue to stay on the right path in terms of wealth creation. 

Now that you know what skills are needed for financial management, feel free to go ahead and draw up a financial plan right away. If you’re having some trouble getting started with this for the first time, you could always seek the help of a financial expert. 

Frequently Asked Questions (FAQs)

1.What skills do you learn in personal finance?

Some of the key skills that you learn in personal finance are setting financial goals, budgeting, building a credit history and investing in the right options. 

2.What is an example of personal finance skills?

Being able to effectively manage your credit cards and other borrowings is a good example of personal financial skills. Other examples include budgeting, tax planning and improving your financial literacy.

3.What are the 3 personal finance strategies?

When it comes to personal finance, there are more than 3 strategies. The strategy that you would need to implement may vary depending on what your financial goals are. A few of the more popular strategies include budgeting, portfolio diversification and investing according to your risk profile. 

4.How can I learn personal finance?

The best way to learn about personal finance is by reading through the many free courses and resources available on the internet. Through this, you can develop the skills that you require to manage your finances more effectively. 

5.What are the 6 principles of finance?

The six principles of finance that you must know are - 

  • Time value of money
  • Risk and return
  • Cash flow
  • Diversity
  • Profitability 
  • Liquidity and hedging
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