“The Journey of a thousand miles must begin with a single step” – Lao Tzu. The single step of analyzing your four pillars will help to provide you with a framework to manage money. Managing money has become the need of the hour. Today youngsters find this as the most difficult task unlike earlier. Irrespective of our income, age, wealth, investment, credit card bill, and other factors we all fit into a common framework called “The Four Pillars of Personal Finance”
The four components are Assets, Liabilities, Income, and expenses. Managing all four components will not only keep you debt-free but also help you attain financial freedom, as said by Rob Berger “The Best thing money can buy is financial freedom”.
Let Us Now Move To The Four Pillars of Personal Finance And Understand Each Component In Depth.
Assets are resources that can be converted into cash within a period of time, however, the turnaround time highly depends on the nature of the asset. Assets are divided into different categories like current assets, fixed assets, tangible, intangible, and operating and non-operating assets. For instance, a house is a tangible asset and even the share that you own is termed as an intangible asset. They both differ in terms of liquidity where shares can be sold quickly and converted into cash, while the house might take a little longer.
Assets also serve as one of the inputs and help increase the net worth. You can list all the assets and add them up to understand your current worth. Getting clarity on your varied assets is the first step to attain financial freedom.
Examples of Assets are- House, Bonds, Mutual funds, Gold, Silver, Antique artefacts, Land, Commercial space, Liquid cash, fixed deposits, and others.
Assets are considered to be one of the strongest components of finance. Why so? It is because this is the only component that gives you strong financial support. The more the assets the more the net worth unless you have more liabilities. Most of the Assets appreciate on their own with time. Some are short-term, few others may be long-term. For example, A house may take longer to appreciate, whereas shares might give you a short-term appreciation. It all depends on the nature and type of asset.
In simple terms, Liabilities refer to the money that you owe to others. Many of us fail to understand the basics of debt management and end up being in debt. Liabilities are opposite to assets and include all the accounts payable. Eg. Student loans, credit cards, bills payable, Mortgages, and others. In addition to this also the interest accrued on all these liabilities will be considered liabilities only. Basically, interests are considered to be indicators of the cost of debt. The higher the credit score the lower the interest rate.
Liabilities aren’t always bad! Especially when it is incurred to create an asset like a house or educating yourself. You should always decide on an upper limit when you consider debt as an option of financing. The goal should be clear that the assets have to be increased over a period of time. Sometimes it might be difficult, but you should stick around it to achieve your long-term goal. Being debt-free is the new rich. Once you identify all your liabilities the best step is to design a debt reduction strategy that will help you gradually pay off the debts and build assets in the long run.
Income refers to all the money that one generates within a period of time. You can calculate either monthly or yearly. Though a monthly calculation is suggested to manage the cash flow, keeping a track of income and expenses will help you achieve short-term goals. Income can be categorized into two parts, First Disposable income, and second discretionary income! Don’t know any? Let us understand both terms. Disposable income is basically income/ money that is left after paying the taxes to the government. This money is used to pay for our day-to-day necessities. Discretionary income is something that is left after paying for the necessities. Hence, Income minus disposable income gives us discretionary income. Discretionary income can be either saved or spent on luxury. You can also use it to pay debts. Therefore, you should use this income wisely and not land up spending unnecessarily.
You should try to increase your income streams. Try building more sources of income that are passive in nature along with active income. For example- one can get into blogging, freelancing opportunities like teaching, etc. Additionally, you can earn income from investments like rental income, interest income, capital gains, etc. There are many options that you can explore only if you are creative. An additional source of income will always keep your balance sheet positive and help in building your net worth. So, start exploring new sources!
It refers to the cash outflow. All the money spent within a period of time that will not generate any revenue is called an expense. Expenses are necessary to run our day-to-day activities. It is advisable to always keep a track of your monthly expenses so that you don’t end up spending more. Recording expenses is a must so that you can check the estimated amount with the actual figure. Tracking your monthly expenses can be a daunting task. You can use an application for the same. Limit your credit card use to avoid unnecessary expenses. Make use of discounts, offers, vouchers, and others while making purchases. Try building a fund for emergency or sudden expenses so that your savings are not hampered. Your financial stability depends on expenses, the more the expense the fewer savings and vice versa. Hence, in order to build a strong financial worth, you need to keep expenses under control and also keep a proper check on them regularly. As said “A penny saved is a penny earned”
I am sure by now you must have understood the four components of personal finance clearly. Implementing it in day-to-day activities is a must to achieve long-term financial freedom. Assets and liabilities will automatically be aligned once the income and expenses are in check. Monitoring all four components will help you analyze your current status and help in planning your long-term goal. Long-term goals can only be achieved with short-term achievements. So, plan and strategize your financial freedom from today. A small step can bring wonders in attaining your retirement and financial freedom on time.
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