What They Are and Why You Need to Know Them
Do you find personal finance complicated? You’re not the only one. Many of us were never taught how to manage, let alone maximize, our financial health. To make it simple, get to know the five pillars of personal finance: earn, save, invest, borrow, and spend. Each of these pillars makes up a part of your financial toolbox. How well you use and nurture these pillars determines your financial situation.
Keeping your five pillars in order will help you achieve your financial goals and protect your future. Take a look at how each pillar works, and discover our tips for achieving financial health:
The first pillar of personal finance is your income or how much you earn. The younger you are, the more critical this pillar is toward contributing to your financial health. That’s because the more money you earn, the more money you have to save and invest in your future.
Your goal in this pillar should be to move toward a better tradeoff of your time for money as you gain more skills over time.
- Always be on the lookout for ways to earn extra income in addition to your regular job. This could include starting your own business, joining the Appen Crowd, working part-time, or another side endeavor.
- Consider moving to a new job if your current role isn’t maximizing your earning potential for the skills that you offer. Don’t stay in a job just because it’s easier than finding another.
Saving is the second pillar of personal finance. You need savings set aside for emergencies. We all experience job loss, health issues, and other life events that can cause financial setbacks. Savings are also useful for achieving short-term goals, such as buying a new car.
It’s important to understand that savings will not generate long-term wealth for you because the interest earned on savings is low. If you have your emergency fund and short-term goals covered, consider investing any additional funds in stocks or retirement funds.
- Create an emergency fund that can cover your expenses for four to six months in the event you lose your job.
- When you’re building up your emergency fund, or saving for a short-term expense, take out the same portion of your income every month to devote toward that goal. Treat that amount as you would any other bill you must pay.
The third pillar, invest, is about making your money work for you. Money invested compounds correctly over time—that means it multiplies without you having to do anything to it. Many people choose to invest in stocks, which have the potential to provide high returns, though real estate is another common investment. Your choice of investments will be dependent on how much of a risk-taker you are and, of course, how much money you are able to invest.
Investing in your future is also incredibly important. That means setting aside money from each paycheck to go into a retirement fund. The earlier you invest that money, the faster it will multiply!
- When is the right time to start investing? Now! Start investing as soon as possible, so your money has time to multiply.
- If you’re unsure where to invest first, many beginners start with mutual funds, as these help diversify your portfolio. Mutual funds pool money from multiple investors to buy a variety of stocks.
Borrow is the fourth pillar of personal finance. Borrowing money isn’t necessarily bad, as long as you don’t borrow more than you can afford. What does that mean in practice? You may need to take out a loan to pay for a house, car, or education. You’ll want to ensure that you’re able to make the required monthly payments on your loans and that these payments don’t overwhelm you financially.
Another method of borrowing money is by using credit cards. You need to pay the full balance of these credit cards off each month; if you cannot do that, it’s recommended that you close your credit cards and use cash or debit instead. That way, you’ll only be using the money you have in your account and not increasing your debt.
- Make at least the minimum payment on all of your loans each month. This will help you maintain good credit.
- Be strategic about which debts you pay off first. In some cases, paying your smallest loan the fastest frees up money to tackle your bigger loans. When you no longer have a minimum payment, you can take the money you had been spending on your small loan and add it to your minimum payment of your next smallest loan. This is called the snowball effect. In some cases, it may make more sense to target the loan with the highest interest rate. By devoting more of your money each month to pay off that loan faster (while still making the minimum payment on the other), you’ll avoid paying extra interest.
The final pillar of personal finance is spending. This is where it’s beneficial to create a budget. On top of savings, investing, and paying off debt, you’ll also have regular expenses that you need to take care of, such as house payments, groceries, and other costs of living. Only after you’ve covered these necessities should you consider spending your money on entertainment, eating out, or additional lifestyle spending.
- Many adults spend a lot of money on insurance, be it for their car, house, or something else. Shop around at many different insurance agencies before selecting one. You never know when you’ll come across a great deal or be able to bundle these together for a discount.
- Follow these five steps to building a perfect budget for you.
If you find that understanding and navigating these five pillars is challenging, you’re not alone. There are many free resources to help you manage each of these parts. Start by consulting a financial advisor, or speaking with someone from your local bank.