Personal Finance Basics -
Your Blueprint To Financial Growth

Personal Finance Basics, Fundamentals of Personal Finance, Personal Finance 101 or other appellation du jour refer to the essentials that comprise the core elements of your financial context and its study.

Learning and continuously informing yourself about the topic is critical to redirecting your financial matters for the better. That is part and parcel of acquiring financial literacy, which is indispensable to lighting the way to financial security. This article outlines the basics you need to be cognizant of in order to improve your financial outlook.

Learning Personal Finance Basics Leads to Financial Growth

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Personal Finance Basics:
1) Income vs Expenses

In an interview, billionaire Richard Branson was once asked what financial advice he could give people. While everyone might expect a very complex answer, he said something that sounded rather simplistic but can prove truly profound in closer inspection. He just said: “Count your money”.

It is mind-boggling how many people, high and low-income alike, don’t know precisely what their financial status is at any given time. The controls tend to be rather loose, with no preplanning and little proaction, mostly day-to-day reaction in place of (admittedly) difficult budgeting.

Predictably, this leads to overspending, and more importantly than overspending, spending more than one earns. The first rule in personal finance, if one must be picked, is that expenses shall not exceed income.

Even though that’s not easy, there are many reasons why violating this rule should come across as fairly logical. But as we will see shortly, it also makes it impossible to save surplus money, a key element that enables people to later invest that surplus, thereby making that money work for them.

Indeed, at some point you want to reach the level where your money works for you instead of you working endlessly for your money.

Personal Finance Basics:
2) Debt

Typically, problems with the “first rule” lead to various levels of indebtedness. Debt must be controlled for the same reason noted above: being able to save a surplus. And after all, debt must be repaid. Thus, it adds to the spending load, usually with interest rates that drain one’s purse even more.

Having said that, there is good debt and bad debt and it’s important to know the distinction in order to use the former to your benefit (including debt for savvy investing), and stay clear of the latter.

Good debt is manageable and ultimately has a positive return on investment (e.g., adds to your wealth, cash flow, valuable education, etc.)

Bad debt depletes your resources and provides no return on investment. It drains cash and is used on things that lose value instead of adding it (e.g., frivolous credit card shopping, upscale dining, wasteful obsession with clothing, shoes, fashion accessories, fancy cars, etc.)

If it is debt that is incurred for something that will not produce financial value, it is likely bad debt and it is unlikely to raise one’s financial standing.

Personal Finance Basics:
3) Credit Cards

 It is not realistic to completely eliminate the use of credit cards in modern Western society. Credit cards play a useful role, and can be not only practical but even beneficial when managed properly.

The better class of credit cards provide many advantages including deals and discounts, cashbacks, special perks, etc.

They obviously also facilitate paying for products and services, but the m.o. should be to avoid ramping up credit card debt and to pay the balance in full each month. At the very least, their usage should be kept within 30% of available credit utilization, 10% or lower being better.

Credit cards are notoriously seductive and harmful to personal finances if not dealt with meticulously. They must never be allowed to accumulate and carry debt over extended periods of time.

Stealthily, they siphon more money off unsuspecting users than you can imagine – a small fortune oozed away over a lifetime. Financially savvy people do not allow their money to be siphoned off by credit card companies.

One way to use credit cards wisely is to take advantage of the 0% interest deals periodically offered for stretches of 12, 15, 18 months, etc. (caution: cash advances may not be covered in the deal – only purchases). Remember to pay any balances off before the 0% interest lapses.

Personal Finance Basics:
4) Credit Score

Your handling of credit cards will partially have an impact on your credit score. A strong credit score is essential for obtaining more and better credit opportunities whenever you need personal loans, business loans, auto loans, mortgage loans, etc.

Your credit profile has become important in other areas of life as well. Examples include potential employers who check your credit as part of background check procedures. Your credit will also be checked for instance when you apply to rent an apartment. This illustrates the necessity to monitor your credit and apply yourself to keeping your score as high as feasible.

In addition to the 3 main credit reporting companies (Equifax, Experian and Transunion) and AnnualCreditReport.com (free) where you can obtain your credit report, websites like Credit Karma (creditkarma.com) and Credit Sesame (creditsesame.com) provide detailed credit information and financial goals assistance that is worth considering.

Their services are free in exchange for your email address and information, leading up to loans, credit cards and other suggestions from them.

FICO is the leading credit scoring service. Their scores range from 300 (poor credit) to 850 (excellent credit). Some of the most important factors that affect your credit score are:

  • The credit utilization ratio (over 30% lowers your score)
  • On-time payments
  • Age of credit accounts

Personal Finance Basics:
5) Budgeting

It might prove an overwhelming challenge to maintain good finances and good credit without some sort of budgeting plan. A budget is essentially a financial plan over a set period of time where expenses are allocated usually in an effort to keep them lower than available funds.

Budgeting can also help to address issues such as eliminating debt or saving for specific goals.

The personal finance community has adopted 4 methods of budgeting known as: Zero-based, Incremental, Activity-based and Value proposition budgeting.

There are many budgeting methods from the simple Kakeibo (Japanese budgeting system) to high-tech apps available on the market that make it possible to structure or even automate budgeting so that it is most effective.

Personal Finance Basics:
6) Emergency Fund

An important aspect of budgeting is to makes sure that you always “pay yourself first”, starting with establishing an “emergency fund”: a reserve you build to enable yourself to face any unexpected financial emergency and survive for a given number of months with your own assets, if you had to.

The amount of your emergency funds depends on the length of time you would feel manageable if you were to not receive any income. Six months is a common target, but this is a personal decision as other things may come into play.

For instance, if you are married and want to be able to cover the needs of your family in case of a crisis, you may lean towards a bigger emergency funds than a young single person with no responsibilities. How much of your income can comfortably be put away is also an optional factor. But, what should not be optional is to not task yourself with building an emergency fund at all.

Once you’ve reached your emergency fund target, it is highly advisable to continue saving at the same rate, or more when possible. That “budget surplus” will be your foundation for tapping investing opportunities and making your money work for you so you can start earning passive income.

The sooner both the emergency fund and the surplus are achieved, the better. A higher paying job and developing side gigs are generally seen as prime solutions for more income.

Personal Finance Basics:
7) Investing

If you have reached this stage of your personal finance basics, you are in fairly good shape and things should be looking up. Investing is a vast topic that spans from IRA 401(k) type retirement accounts through employers, to stocks and index funds, or investing in start-ups, personal small businesses, etc.

The main takeaway in investing is that, after you have successfully put yourself in a position where you have surplus funds, it is time to consider investments that suit you, and not let your money sit in a bank account doing nothing.

As you know or may not know, a dollar today does not have the same purchasing power as the same dollar a few years from now. So, put it to work so it doesn’t lose value through sheer inflation. While you’re at it, work on multiple streams of income for multiplication as well as diversification - so you never have all your eggs in one basket.

Personal Finance Basics:
8) Insurance

Now that your financial intelligence is stimulated, you don’t want to forget smartly protecting your financial house and everything you’ve been working for. This entails sacrificing a small amount of your financial resources to prevent losing significant value in case of an accidental occurrence.

Insurance can be a necessary evil because no one wants to “waste” money on paying premiums every month, but the downside of not having insurance can be disastrous on many levels, including on one’s own health precariousness.

Insurance is also a necessity to protect those we love who may be vulnerable without that extra layer of protection.

Review more personal finance basics discussed in more depth on various articles that we offer.

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