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A guide to personal finance: The basics

It’s important to understand the basics of personal finance if you want to get a leg up on economic success. Here we cover the fundamentals of setting goals, saving, and investing.

Video Transcript

- Personal finance is economics on the family and individual levels. It encompasses goal setting, financial action plans, various investments, and how small everyday choices impact your financial life. Setting goals help you make wise financial decisions. Goals should be clear, concise, detailed, and written down. They also should be realistic.

You need to determine how much more you need to accumulate and when you will need it to achieve your goal. When a goal must be achieved by a specific date, you must plan conservatively, save more money, and take less investment risk to help insure against loss. But if the timing isn't as important, you might be able to invest more aggressively.

Goals should be grouped as short-term, three years or fewer, medium term, three to seven years, and long-term, more than seven years. Generally, the longer time horizon, the more aggressive you can be in your investment approach.

Next, build a financial action plan that details how you plan to achieve your goals. Here's a simple one. Your goal-- pay off $1,000 balance on a credit card in 12 months. Task one, determine the amount that must be paid each month. Task two, set aside that amount each month by cutting out unnecessary expenses. And task three, take on a part-time or temporary job to raise the needed money.

The financial action plan often contains more than one goal. Always monitor your plan at the end of every month to make sure you're on track. Revise it based on how well you're sticking to it. Last, savings and investment should be used to match your short, medium, and long range financial goals. How you save and invest depends on the purpose. For example, if you need to replace a household appliance costing a few hundred dollars in the next 12 to 18 months, you would save differently than if you are saving to pay for a child's education in 10 to 15 years.

To make these decisions, you need to understand the relationship among investment risk, time horizon, and investment reward. Low risk investments should be used for short-term goals and higher risk ones for longer term goals. Savings can also help. Look closely at your spending by tracking it. See where you are leaking money needlessly and make changes. Then divert these small amounts into savings or investments where they can grow in value and help you achieve your financial goals. Stay financially fit, friends.