The term “personal finance” refers to how you manage your money and plan for your future. All of your financial decisions and activities have an effect on your financial health. We are often guided by specific rules of thumb, such as “don’t buy a house that costs more than two-and-a-half years’ worth of income” or “you should always save at least 10% of your income toward retirement.”
While many of these adages are time tested and helpful, it’s important to consider what we should be doing in general to help improve our financial health and habits. Here we discuss five broad personal finance rules that can help get you on track to achieving specific financial goals.
As a starting point, it is important to calculate your net worth, the difference between what you own and what you owe. To calculate your net worth, start by making a list of your assets (what you own) and your liabilities (what you owe). Then subtract the liabilities from the assets to arrive at your net-worth figure.
Your net worth represents where you are financially at that moment, and it is normal for the figure to fluctuate over time. Calculating your net worth one time can be helpful, but the real value comes from making this calculation on a regular basis (at least yearly). Tracking your net worth over time allows you to evaluate your progress, highlight your successes, and identify areas requiring improvement.
Most individuals will spend more money if they have more money to spend. As people advance in their careers and earn higher salaries, there tends to be a corresponding increase in spending, a phenomenon known as “lifestyle inflation.” Even though you might be able to pay your bills, lifestyle inflation can be damaging in the long run, because it limits your ability to build wealth. Every extra ringgit you spend now means less money later and during retirement.
One of the main reasons people allow lifestyle inflation to sabotage their finances is their desire to keep up with the Joneses. It’s not uncommon for people to feel the need to match their friends’ and coworkers’ spending habits. If your peers drive BMWs, vacation at exclusive resorts, and dine at expensive restaurants, you might feel pressured to do the same. What is easy to overlook is that in many cases the Joneses are actually servicing a lot of debt over a period of decades to maintain their wealthy appearance. Despite their wealthy “glow” the boat, the fancy cars, the expensive vacations, the private schools for the kids, the Joneses might be living paycheck to paycheck and not saving a dime for retirement.
As your professional and personal situation evolves over time, some increases in spending are natural. You might need to upgrade your wardrobe to dress appropriately for a new position, or, as your family grows, you might need a house with more bedrooms. And with more responsibilities at work, you might find that it makes sense to hire someone to mow the lawn or clean the house, freeing up time to spend with family and friends and improving your quality of life.
Unless you have an unlimited amount of money, it’s in your best interest to be mindful of the difference between “needs” and “wants,” so you can make better spending choices. Needs are things you have to have in order to survive: food, shelter, healthcare, transportation & etc. Conversely, wants are things you would like to have but don’t require for survival.
It can be challenging to accurately label expenses as either needs or wants, and for many the line gets blurred between the two. When this happens, it can be easy to rationalize away an unnecessary or extravagant purchase by calling it a need. A car is a good example. You need a car to get to work and take the kids to school. You want the luxury edition SUV that costs twice as much as a more practical car (and costs you more in gas). You could try and call the SUV a “need” because you do, in fact, need a car, but it’s still a want. Any difference in price between a more economical vehicle and the luxury SUV is money that you didn’t have to spend.
Your needs should get top priority in your personal budget. Only after your needs have been met should you allocate any discretionary income toward wants. And again, if you do have money left over each week or each month after paying for the things you really need, you don’t have to spend it all.
It’s often said that it’s never too late to start saving for retirement. That may be true (technically), but the sooner you start, the better off you’ll likely be during your retirement years. This is because of the power of compounding, what Albert Einstein called the “eighth wonder of the world.”
Compounding involves the reinvestment of earnings, and it is most successful over time. The longer earnings are reinvested, the greater the value of the investment, and the larger the earnings will (hypothetically) be.
To illustrate the importance of starting early, assume you want to save RM4,112,500.00 by the time you turn 60. If you start saving when you are 20 years old, you would have to contribute RM2,694.92 a month, a total of RM1,293,562.20 over 40 years to be a millionaire by the time you hit 60. If you waited until you were 40, your monthly contribution would bump up to RM10,005.26 a total of RM2,401,264.07 over 20 years. Wait until 50 and you’d have to come up with RM26,484.01 each month equal to RM3,178,082.42 over the 10 years. (These figures are based on an investment rate of 5% and no initial investment. Please keep in mind that they are for illustrative purposes only and do not take into consideration actual returns, taxes, or other factors).
The sooner you start, the easier it is to reach your long-term financial goals. You will need to save less each month, and contribute less overall, to reach the same goal in the future.
An emergency fund is just what the name implies, Money that has been set aside for emergency purposes. The fund is intended to help you pay for things that wouldn’t normally be included in your personal budget, unexpected expenses such as car repairs or an emergency trip to the dentist. It can also help you pay your regular expenses if your income is interrupted for example, if an illness or injury prevents you from working or if you lose your job.
Although the traditional guideline is to save three to six months’ worth of living expenses in an emergency fund, the unfortunate reality is that this amount would fall short of what many people would need to cover a big expense or weather a loss in income. In today’s uncertain economic environment, most people should aim for saving at least six months’ worth of living expenses, more if possible. Putting this as a regular expense item in your personal budget is the best way to ensure that you are saving for emergencies and not spending that money frivolously.
Keep in mind that establishing an emergency backup is an ongoing mission. Odds are that as soon as it is funded, you will need it for something. Instead of being dejected about this, be glad that you were financially prepared and start the process of building the fund again.
