Personal finance is the financial management that an individual or a family unit performs to budget, save, and spend monetary resources in a controlled manner, taking into account various financial risks and future life events.
When planning personal finances, the individual would take into account the suitability of various banking products (checking accounts, savings accounts, credit cards, and loans), insurance products (health insurance, disability insurance, life insurance, etc.), and investment products (bonds, stocks, real estate, etc.), as well as participation in monitoring and management of credit scores, income taxes, retirement funds and pensions.
Before a specialty in personal finance was developed, various disciplines which are closely related to it, such as family economics, and consumer economics, were taught in various colleges as part of home economics for over 100 years.[1]
The earliest known research in personal finance was done in 1920 by Hazel Kyrk. Her dissertation at University of Chicago laid the foundation of consumer economics and family economics.[1] Margaret Reid, a professor of Home Economics at the same university, is recognized as one of the pioneers in the study of consumer behavior and Household behavior.[1][2]
In 1947, Herbert A. Simon, a Nobel laureate, suggested that a decision-maker did not always make the best financial decision because of limited educational resources and personal inclinations.[1] In 2009, Dan Ariely suggested the 2008 financial crisis showed that human beings do not always make rational financial decisions, and the market is not necessarily automated and corrective of any imbalances in the economy.[1][3]
Research into personal finance is based on several theories, such as social exchange theory and andragogy (adult learning theory). In America, professional bodies such as American Association of Family and Consumer Sciences and the American Council on Consumer Interests started to play an important role in developing this field from the 1950s to the 1970s. The establishment of the Association for Financial Counseling and Planning Education (AFCPE) in 1984 at Iowa State University and the Academy of Financial Services (AFS) in 1985 marked an important milestone in personal finance history in the US. Attendances of the two societies mainly come from faculty and graduates from business and home economics colleges. AFCPE started to offered several certifications for professionals in this field, such as Accredited Financial Counselor (AFC) and Certified Housing Counselor (CHC). Meanwhile, AFS cooperates with Certified Financial Planner (CFP Board).[1]
Before 1990, the study of personal finance received little attention from mainstream economists and business faculties. However, several American universities such as Brigham Young University, Iowa State University, and San Francisco State University started to offer financial educational programs in both undergraduate and graduate programs since the 1990s. These institutions published several works in journals such as The Journal of Financial Counseling and Planning and the Journal of Personal Finance.
As the concerns about consumers' financial capability increased during the early 2000s, various education programs emerged, catering to a broad audience or a specific group of people, such as youth and women. The educational programs are frequently known as "financial literacy". However, there was no standardized curriculum for personal finance education until after the 2008 financial crisis. The United States President's Advisory Council on Financial Capability was set up in 2008 to encourage financial literacy among the American people. It also stressed the importance of developing a standard in financial education.[1]
It is hard to define universal personal finance principles because:
A financial advisor can offer personalized advice in complicated situations and for high-wealth individuals. Still, University of Chicago professor Harold Pollack and personal finance writer Helaine Olen argue that in the United States, good personal finance advice boils down to a few simple points:[4]
The key component of personal finance is financial planning which is a dynamic process requiring regular monitoring and re-evaluation. In general, it involves five steps:[5][6]
Typical goals that most adults and young adults have are paying off credit card/student loan/housing/car loan debt, investing for retirement, investing for college costs for children, and paying medical expenses.[7]
In the modern world, there is a growing need for people to understand and take control of their finances because of the following reasons:
1. Lack of comprehensive formal education: Although many countries have some formal education for personal finance, the Organization for Economic Co-operation and Development (OECD) studies show low financial literacy in areas it is not required, even in developed countries like Japan.
This illustrates the importance of learning personal finance from an early stage,[9] to differentiate between needs vs. wants,[10] improve financial literacy, and to build financial planning skills..
2. Shortened employable age: Over the years, with the advent of automation [11] and changing needs; it has been witnessed across the globe that several jobs that require manual intervention or that are mechanical are increasingly becoming redundant.
These are some of the reasons why individuals should start planning for their retirement and systematically build on their retirement corpus,[15] hence the need for personal finance.
3. Increased life expectancy:[16] With the developments in healthcare, people today live till a much older age than previous generations. The average life expectancy has increased even in developing economies. The average life expectancy has gradually shifted from 60 to 81[16] and upwards, which coupled with a shorter employable age reinforces the need for a large enough retirement corpus and the importance of personal finance.
4. Rising medical expenses:[17] Medical expenses including cost of prescription medicine, hospital admission care and charges, nursing care, specialized care, geriatric care have all seen an exponential rise over the years. Many of these medical expenses are not covered through insurance policies that might either be private/individual insurance coverage or through federal or national insurance coverage.
These reasons illustrate the need to have medical, accidental, critical illness, life coverage insurance for oneself and one's family as well as the need for emergency corpus;[20].
Critical areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:[21]
Although credit can provide a variety of benefits and opportunities to the borrower, it is important to fully understand the advantages and disadvantages to borrowing to ensure sound financial decisions.[24] Using credit indiscriminately and lack of sufficient education can land an individual into debt and disadvantaged situations. Typical downsides of using credit are:
According to a survey done by Harris Interactive, 99% of the adults agreed that personal finance should be taught in schools.[25] Financial authorities and the American federal government had offered free educational materials online to the public. However, a Bank of America poll found that 42% of adults were discouraged. In comparison, 28% of adults thought that personal finance is difficult because of the vast amount of online information. As of 2015, 17 out of 50 states in the United States require high school students to study personal finance before graduation.[26][27] The effectiveness of financial education on general audience is controversial. For example, a study by Bell, Gorin, and Hogarth (2009) stated that financial education graduates were more likely to use a formal spending plan. Financially educated high school students are more likely to have a savings account with regular savings, fewer overdrafts, and more likely to pay off their credit card balances. However, another study done by Cole and Shastry (Harvard Business School, 2009) found that there were no differences in saving behaviors of people in American states with financial literacy mandate enforced and the states without a literacy mandate.[1]
Kiplinger publishes magazines on personal finance.[28]
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