Getting Started with Personal Finance
At Luniate, we're all about making finance less intimidating.
Remember though, finance isn't just about big corporate stuff. It starts and ends with regular people like you and me—and for each of us, what matters most is our own personal financial situation.
We've discovered that, similar to how a company's finances come down to a few basic principles, personal finance is actually pretty straightforward at its core.
So we've done all the research, put in the hours, found the golden nuggets, and cut out all the fluff to show you how to achieve financial freedom through just a few simple steps.
In this guide, we'll start by focusing on securing and protecting your money: helping you figure out which debts are actually helpful versus harmful, and whether your saving and budgeting methods are working for you.
Then we'll address some major questions about managing finances in your everyday life. Finally, we'll explore how you can grow your savings today to create a solid financial foundation for your future.
Introduction to Personal Finance: Clearing the Path Ahead
Reduce Your Debt to Clear Your Financial Path
Debt often gets a bad reputation—but not all of it deserves it. Some debt can actually be beneficial—so how do you tell the difference?
Bad Debt vs. Good Debt
As you begin your financial journey, you'll want a clear road ahead. That might mean eliminating outstanding debt. While debt often gets criticized, not all criticism is deserved. Some debt can actually be beneficial—so how can you tell which is which?
Basically, good debt provides financial benefits beyond the money itself, ultimately leaving you better off (that's a win!). For example, after you've paid off a mortgage, you become the sole owner of a property that can increase in value and potentially generate rental income. Student loans are typically good debt too, since higher education can improve your career prospects and earning potential.
But watch out for bad debt. It takes without giving back, providing no future financial benefit. Using credit for shopping sprees, luxury vacations—or covering those never-ending bills won't do your future self any favors.
Getting Rid of Bad Debt
One straightforward way to tackle expensive bad debt is to transfer outstanding credit card balances.
Though there are usually initial fees involved, some credit cards let you move existing debt to a new card interest-free (temporarily). This should help you pay off your balance more easily—but be careful not to add to it, since you'll likely be charged interest on new purchases.
For larger or longer-term debts, consolidation might work better. By taking out a single new loan to pay off all your other loans, you might reduce your interest costs and, again, pay off your balance faster.
Budgeting Basics
Several good budgeting apps can help track your income and expenses—and when in doubt, you can always go old-school with pen and paper.
Whatever budgeting tool you prefer, here are a couple approaches that will help turn those pennies into pounds, dollars, or euros to meet your financial goals—whether buying a home or planning your retirement.
The approach championed by none other than the "Oracle of Omaha" himself, billionaire investor Warren Buffett, is to pay yourself first.
He suggests directing money from your paycheck straight into a savings or investment account before doing anything else. Of course, leave enough for necessary expenses. But the idea is that money out of sight is money out of mind—and less likely to be spent on restaurants or shoes.
And teamwork can make the dream work. Like going to the gym, sometimes budgeting works better with a friend to hold you accountable.
This probably requires complete honesty about your spending habits, so your buddy knows what to watch for—but it can provide excellent motivation, especially if you're working toward goals together.
Ready for Whatever Life Throws at You
Alright, now that you've got the basics down, you're ready to continue your journey. Next up: protecting yourself and your wealth against life's surprises.
Protect: Expecting the Unexpected
What Is an Emergency Fund?
An emergency fund is money set aside for unexpected financial challenges. Whether it's losing your phone, your job—or even a few teeth—these events can be costly as well as stressful.
It's important to prepare for the unexpected, and you'll appreciate having saved for an umbrella when storm clouds appear. A good rule of thumb is to have three months' after-tax salary set aside to help you through life's more difficult periods.
Unfortunately, the average Brit has less than one month's salary saved for emergencies. And in the US, 20% of people don't save any of their salary at all.
This can easily lead to increasing debt (the bad kind), because when a financial emergency happens, you'll be forced to borrow—ultimately making your financial situation worse due to interest payments.
The good news is that you can start building your emergency fund right now. Saving as little as $10 or £10 monthly soon adds up. Consider keeping your cash in a savings account with "instant access," meaning you can withdraw it quickly when needed—and while it sits there, it'll also earn some interest.
Insurance – For When Life Throws You a Curveball
The complicated world of insurance is made even more complex by different rules across countries. Regardless of where you live, there are two types of insurance particularly worth considering.
Life insurance is essential for those with dependents. It protects your loved ones from an even greater financial burden if the worst should happen to you.
Popular options include policies that pay off the remainder of a mortgage; those that promise a fixed payment if you pass away within a certain period; and those that guarantee a payment regardless of how long you live. A rule of thumb is to insure yourself for 10 times your annual salary.
Similarly, income protection insurance steps in if you can't work due to illness or injury. For a small monthly fee, it activates when you're unable to work, replacing your lost income until you recover (or until the policy ends). This may be especially important if you have family members depending on your income.
Choosing Wisely
You've worked through debts, budgeting, and protecting yourself against unexpected circumstances. What's next?
Live: Enabling Life's Big Choices
You've navigated through debts, budgeting, and protecting yourself against unforeseen events. But what's financial freedom without enjoying the rewards of your hard work?
Everyone deserves a small spontaneous treat occasionally, which we leave up to you; but when it comes to saving for major financial decisions, let's tackle them together...
Saving for Goals Up to Three Years Away
Generally, financial goals within three years are considered "short-term." Money for these goals may be better kept in a savings account.
But when saving, remember: the key is maintaining your money's value. That means not letting it be eroded by inflation, which is the rate at which prices for goods and services increase.
Rising inflation means a dollar, pound, or euro buys less each passing year. Money earning no interest loses value over time. For example, annual inflation of 3% would halve your cash's value in just 24 years.
As you budget and save, therefore, look for savings accounts with interest rates higher than inflation to limit your losses.
What's the Best Account for Your Savings?
Two popular savings options in the UK are fixed-term savings accounts, similar to American certificates of deposit (or CDs), and flexible cash Individual Savings Accounts (ISAs), which don't have a direct US equivalent. The closest is an Individual Retirement Account (IRA)—but more on that later.
With fixed-term saving, your money is locked away—as the name suggests—for a specific period. In exchange for not accessing your money immediately (without paying a fee), banks offer higher interest rates.
What a cash ISA gains in flexibility, it loses in returns. You can deposit and withdraw money as needed, but compared to a fixed-term account, you'll typically earn less interest. On the positive side, any interest earned on savings up to £20,000 annually is tax-free.
Using Your Pension to Save for the Long Term
Employees of many companies can have their pension contributions matched by employers. Depending on your level of control, a pension can be another investment vehicle; that money goes into a fund managed on your behalf.
You might be better off maximizing pension contributions before doing any direct investing yourself—and may want to consider using a self-invested personal pension (SIPP), which gives you more control over your investments.
You can manage everything yourself, instead of having a professional investment manager make decisions for you. However, managing your pension this way can become expensive—so be careful about high fees.
Looking to the Future
We're almost at the end of your personal finance journey. Of course, true financial freedom is ongoing. And to get there, you need to look beyond tomorrow. Looking to the future means saving—and investing—for the long term.
Grow: Looking Over the Horizon
What's the Point of Investing?
Investing is about significantly growing your money over the longer term, allowing modest annual gains to build into something impressive.
Investing helps you meet medium-term (roughly three to five years) and long-term (five years and beyond) financial goals. When investing, you accept the risk that your savings might decrease in value—but in return, you create potential for much larger gains.
Planning Your Investment
Begin by determining how much money you can invest toward longer-term goals—remember, this is separate from your emergency fund. If you've followed Warren Buffett's advice to "pay yourself first," you should have a good idea of how much you can set aside monthly.
Next, decide your risk tolerance, perhaps based on how soon you might need to access your money.
Generally, the more long-term the investment, the more risk you should be able to handle. Because—while values can definitely decrease as well as increase—you'll have more time to recover from any short-term losses.
Active vs. Passive Investing
Next, decide whether you want to be hands-off (or "passive") with your investments or hands-on (or "active").
Passive investors typically spread their money across a few exchange-traded funds, then relax and don't think about them much. If the markets you're invested in rise, so does your money.
Similarly, when those markets decline, your investment loses value. Passive investors, therefore, are content for their investments to perform about as well as the overall market average.
Active investors regularly buy and sell stocks, bonds, funds, and so on—aiming to outperform the market's average returns. Some investors do this themselves—others pay investment managers to do it for them, accepting higher fees for the possibility of above-average returns.
Starting to Invest
When it comes to buying and selling investments, you have several options.
Direct
This is the most hands-on approach, where you select and manage all investments yourself. Many people do this through online platforms (or "brokerages") that provide access to various investments, without advice. If you feel confident in your stock market knowledge, you might start here.
Wealth Managers
If you begin with substantial savings, you might consult an independent financial advisor (IFA) or wealth manager. They'll consider your personal circumstances—risk tolerance, investment goals, and timeframes—and recommend suitable investments. You won't handle the buying or selling yourself.
Online Investment Management
If you don't have enough money to justify hiring a wealth manager, but also lack time to make all investment decisions yourself, you might choose online portfolio management—where investment experts (or computer algorithms, for "robo-advisors") build a strategy and manage your money based on your financial goals.
You don't have to choose just one approach. Instead, you can combine strategies—keeping some money in a bank, some in passive investments, and actively managing the rest. Many investors make some direct investments while maintaining a managed portfolio. For more information on investment strategies, check out our detailed guides on what to watch for and how to get started.
What About Tax?
Ah, tax. Whether your money grows through interest or investment gains, you'll want to keep as much as possible—which means taking advantage of tax-free investment and savings options.
For UK Investors
Any money earned from an ISA will be tax-free. You can invest up to £20,000 annually into this type of tax-free account—and there are different varieties, depending on your goals:
- Cash ISAs—which we explained earlier.
- Stocks and Shares ISAs offer a tax-free way to invest your savings however you choose—they're especially helpful if your portfolio performs well, allowing you to keep more gains for yourself.
- Lifetime ISAs help you save toward your first home or retirement. Note that you can only put £4,000 of your annual allowance toward this type of account each year.
- Innovative Finance ISAs offer tax-free returns from peer-to-peer investments.
- Junior ISAs allow you to save for your children. These have an annual investment limit of £4,280, in addition to your own allowance.
A final note on ISAs: use it or lose it! Your annual ISA allowance can't carry over to the following year—so unused portions disappear when your allowance resets annually.
For American Investors
Americans, we haven't forgotten you. Your best tax-advantaged options for the long term (think: retirement) are employer-sponsored 401(k) plans and Individual Retirement Accounts (IRAs).
You can contribute $18,500 yearly to your 401(k) and $5,500 to your IRA. After age 50, that limit increases by $6,000 for a 401(k) and $1,000 for an IRA. (Note that these limits change annually to account for inflation.)
Besides its higher limit compared to an IRA, 401(k) contributions from your salary can be matched by your employer, effectively doubling your money before it's invested.
An IRA therefore provides a way to save extra for retirement. And you can have both. But withdrawing from either your IRA or 401(k) before retirement age likely means facing penalties.
Traditional vs. Roth* 401(k)
*Don't worry—we haven't abandoned our principles and decided to overwhelm you with jargon. "Roth" is just the term officials in the US chose to distinguish between two 401(k) types. Because "version two" was apparently too straightforward...
The main difference between traditional and Roth 401(k)s is when you pay tax. With a traditional 401(k), your contributions reduce your annual tax bill—while with a Roth 401(k), you contribute after taxes have been deducted.
A Roth 401(k) doesn't provide an immediate tax advantage. However, when you withdraw your money in retirement, you won't owe additional tax. So choosing between Roth and traditional plans means deciding whether you'd prefer paying tax now or during retirement.
If you're earning significantly now, a traditional 401(k) should mean lower overall taxes, since plan contributions are tax deductible. But if you're still building your career, a Roth could benefit you long-term—paying tax today might be worthwhile to avoid higher taxes in retirement. Of course, contributing to both types (within your total annual limit) is an option—sometimes called "tax diversification."
You're All Set
And that's it. Follow these stages, and your personal finances will be well-positioned for success.
Just remember: the journey of a thousand miles begins with a single step. So whether you're currently focused on building your emergency fund or looking at long-term investments, we hope this guide helps direct you toward personal financial freedom.
