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The importance of personal finance objectives

the importance personal finance objectives

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There is a lot of talk about personal finances and the methods or formulas to manage them. First of all, it is important to understand the importance it has in our lives and the purpose of dedicating a good number of hours per month and a high level of effort and concentration to this activity.

The main objectives of personal finance are:

  1. Help to accurately understand the current financial situation
  2. Estimate the value of present and future needs, desires, and goals.
  3. Meeting financial needs
  4. Anticipate risks and plan mitigation measures
  5. Define a roadmap to guide financial decisions, so that goal are met

Help to accurately understand the current financial situation

It sounds simple but it is not easy. More than 90% of the clients we counsel do not accurately understand their financial situation at the time they start the counseling program. Some reasons:

  • We underestimate the amount of information. It is very likely that per month an adult person makes more than 100 transactions (income, expenses, payments, etc.). In a year there are more than 1,200 transactions in 18 budget lines. Just calculating the monthly variations alone brings the number to 2,400 figures. That’s not counting the budget. Calculating all this in your head is no easy task.
  • We believe we can mentally calculate interest. The interest you earn and pay follows an exponential function, which is very difficult to calculate mentally; our brain generally projects linearly. This difficulty produces very significant estimation errors when estimating the value of interest.
  • We tend to overestimate income and underestimate our expenses.
  • We spend a lot of time making money; not much time managing or growing the money we already make. Just as in a business, we must spend time and effort to manage.
  • We don’t know how

Based on our clients’ statistics, I make the following generalization: Not knowing detailed financial information leads to errors in judgment, and these lead to poor or inopportune decisions.

Personal finance helps you to accurately understand your current situation in a tailored way and therefore make better decisions.

Estimating the value of present and future needs

Establishing and understanding the current financial situation of a person or family allows us to clearly understand the value of needs and prioritize spending. This way we know how much the essential value of our necessities costs and how much the value of luxury or optional expenses is.

With this method, we also estimate future needs. For example, at the time of writing, my wife is in her seventh month of pregnancy. Naturally, we have already budgeted for what our little Lucas will need, from the first day’s clothes to the monthly savings we have to make for his college.

It is normal for the budget to deviate from reality; there is a lot of uncertainty; in any case, it is better to have a good plan and adjust it than to have no plan at all.

Remember this famous quote by Benjamin Franklin: “If you fail to plan you plan to fail“.

Meeting financial needs

Once you have a detailed understanding of your and your family’s needs (utilities or supplies, food, housing, transportation, clothing, entertainment, health services, education, etc.), the next step is to ensure that you can meet them.

If the sum of your expenses is 1,000 USD per month and your salary is 900 USD per month, you know there is a difference.

By consciously managing personal finance objectives, you KNOW in advance that there is a gap and you have the time and opportunity to close it.

If you don’t manage your personal finances in an organized way, it is very easy to BELIEVE that you earn more than you spend, but in reality, you don’t. This erroneous belief, based on a biased estimate, causes you to relax and not make the strong and timely decisions required. This erroneous belief based on a biased estimate causes you to relax and not make the forceful and timely decisions that are required.

This situation I am describing is much more frequent than you might imagine.

He who knows he has the gap is more prudent and thorough with spending and seriously evaluates options to increase his income so that every month he is not only able to meet the needs but also to save consistently.

I invite you to read our article “How to earn more money“.

Anticipate risks and plan mitigation measures

It’s not as boring as it sounds, believe me. It is amazing that some companies contemplated the possibility of a pandemic before it happened.

Amazon foresees possible disruptions to its global supply chain. Google foresees possible failures or attacks on its data centers (where we all store our emails). Apple foresees the possible hacking of its data centers. McDonald`s foresees the risk of intoxication of its customers with spoiled or contaminated food. All this information is public, I invite you to read it; it is very interesting.

In the same way that corporations foresee and estimate these risks and go ahead to design ways to mitigate them, so does an individual or a family.

For example:

  • Have you foreseen losing your job?
  • Get robbed?
  • Have an illness or disability?
  • That the bank where you have your savings will fail?
  • That your investments lose 50% of their value?

I naturally hope that none of this will happen! However, a good manager and a responsible parent take time each year to at least foresee the major risks and make sure.

Obviously, you have to be sensible. If your town has never had an earthquake in the last 2,000 years, it is unlikely to happen. But if you live in a town located on the San Andreas fault, such as San Francisco, it is hardly obvious that you will be prepared for an earthquake.

Mitigating these risks has impacts, whether you take insurance, self-insure, buy emergency kits or take first aid courses. Well-structured personal finances always contemplate these scenarios and their mitigation plans.

Define a roadmap to guide financial decisions, so that objectives are met

If you were a little overwhelmed with the paragraph about risks, it’s time to move on to the more pleasant part of personal finance: goals.

Few exercises are more enjoyable than planning your future:

  • In which city do you want to live in 5 years
  • To which countries do you want to travel
  • In which house or apartment do you want to be in 3 years’ time?
  • What do you want to do in 10 years?
  • What hobbies do you want to have

Ultimately, what do you want your life to be like in the future? There are people who prefer to live for the day; I deeply respect this position. However, I love to exercise the privilege that life gives me to dream and to be able to design my life to be better in the future, for me, my family, and those around me.

Many people have achieved incredible lives, unimaginable victories, and unimaginable constructions because years or decades before they took the freedom to think, to create their future.

As you thoroughly detail what this future you want so badly looks and feels like, you will be able to plan for it and bring it into your personal finances.

You will know how much you need to save month by month, how much you need to earn and spend, and even how much your investments should yield to reach your dream goal.

Remember that you can create a life by design or by accident. Only you decide.

How should personal finances be managed?

This question is of a high caliber. I firmly believe that the four steps to define a personal finance structure aligned with the purposes we saw at the beginning are the following:

  1. Understand your current financial situation
  2. Set your goals for the future
  3. Define a plan to get from the current situation to the proposed goal.
  4. Make a follow-up plan to ensure the execution of the plan.

Conclusion on Personal Finance Objectives

The importance of personal finance can be summarized in the following objectives:

  1. Help to accurately understand the current financial situation
  2. Estimate the value of present and future needs, desires, and goals.
  3. Meeting financial needs
  4. Anticipate risks and plan mitigation measures
  5. Define a roadmap to guide financial decisions, so that goal are achieved

What are the steps to structure my personal finances?

  1. Understand your current financial situation
  2. Set your goals for the future
  3. Define a plan to get from the current situation to the proposed goal.
  4. Make a follow-up plan to ensure the execution of the plan.
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