(This is the 2nd article in the Money 101 Managing Your Money Series. We advise that you start from the the first article in the Series. Please click here to go to the Money 101 Managing Your Money introduction)

a. What, exactly, is personal finance mangement?

Personal finance management is the handling and control of your money. It is the taking into consideration your income, seeking to maximize that income and balancing its spread over lifestyle expenditure, saving, accumulation and investment.

In simpler term, it’s about being able to make the money that you earn meet your expenses, and help you achieve certain goals. It also includes avoiding getting into bad debt.

b. Personal finance planning

Personal finance planning is the process through which you identify the ways and means by which you can maximize your income and best distribute it to achieve certain set goals. It involves the identification of financial goals and objectives, the assessment of your current financial position, creation and execution of a plan to achieve stated financial goals, and constant monitoring, assessment and re-adjustment where necessary.

When personal finance planning is mentioned, most people think of budgeting, tightening their belts and lives of forced or imposed poverty. However, this is not the case. With proper finance planning, life is actually a lot better and a lot easier. You do not have to worry about

c. Areas of personal finance planning

The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:

• Position: this area is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is your balance sheet, calculated by adding up all the things that you own, minus all the debts that you owe, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year. From this analysis you can determine to what degree and in what time the personal goals can be accomplished.

• Adequate Protection: The analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance.. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.

• Tax Planning: Typically the income tax is the single largest expense in a household. Managing taxes is not a question of if you will pay taxes, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden.. Typically, as your income grows, you pay a higher marginal rate of tax. Understanding how to take advantage of the myriad tax breaks when planning your personal finances can make a significant impact upon your success.

• Investment and Accumulation Goals: Planning how to accumulate enough money to acquire items with a high price is what most people consider to be financial planning. The major reasons to accumulate assets is for items such as Purchasing a house, Purchasing a car, Starting a business, Paying for education expenses, Accumulating money for retirement, to generate a stream  of  income to cover lifestyle expenses etc . Achieving these goals requires projecting what they will cost, and when you need to withdraw funds. A major risk in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.

• Retirement Planning: Retirement planning is the process of understanding how much it costs to live at retirement and coming up with a plan to make sure you have enough in assets to cover any shortfalls in income that may arise with retirement.

• Estate Planning: Involves planning for the disposition of your asset when you die. You can leave your assets to family, friends or charitable groups

d. Steps of personal finance planning

1. Setting goals: Two examples are “retire at age 65 with a personal net worth of KES 50,000,000″ and “buy a house in 3 years paying a monthly mortgage servicing cost that is no more than 25% of my gross income”. It is not uncommon to have several goals, some short term and some long term. Setting financial goals helps direct financial planning.
2. Assessment: One’s personal financial situation can be assessed by compiling simplified versions of financial balance sheets and income statements. A personal balance sheet lists the values of personal assets (e.g., car, house, clothes, stocks, bank account), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statement lists personal income and expenses.
3. Creating a plan: The financial plan details how to accomplish your goals. It could include, for example, reducing unnecessary expenses, increasing one’s employment income, or investing in the stock market.
4. Execution: Execution of one’s personal financial plan often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
5. Monitoring and reassessment: As time passes, one’s personal financial plan must be monitored for possible adjustments or reassessments.

e. Benefits of proper financial management

With money being one of, if not THE, biggest concern for most people, the benefits of good financial planning and proper management of personal finances are wide and far reaching and include:

• Happiness. As Aristotle put it, ‘Happiness belongs to the self-sufficient’
• Stable marriages
• Better productivity at work which, hopefully, leads to more money
• Freedom
• Achievement

Next: Money 101 – Lesson 2: Setting Goals

1. Money 101 – Lesson 1:  Introduction to Personal Finance
2. Money 101 – Lesson 2: Goal Setting
3. Money 101 – Lesson 3: Assessment
4. Money 101 – Lesson 4: Understanding the Tools
5. Money 101 – Lesson 5: Creating a Plan
6. Money 101 – Lesson 6: Implementation
7. Money 101 – Lesson 7: Monitoring and Assessment