There are four pillars of personal finance; assets, liabilities, income, and outflow. Each pillar represents a vital component of the snapshot into your net worth. Knowing your net worth will provide you with a personal evaluation of your financial goals, allowing you to carry on or pivot to make your dreams happen.
What is Personal Finance?
It’s simple, really. Its how you manage your money. The broad term personal finance covers everything from investing to budgeting, from balancing your checkbook (do people still do that?) to planning a home purchase.
Everyone has their way of managing their money, and some handle it by NOT managing it.
Personal finance education is essential. It’s best to plan for your future, whether that’s 40 years down the line or next month.
Knowing how much you have coming in, how much you have going out, and being in complete control is proper money management and financial planning.
To break it down, each person has their framework of personal finance. There are four main components: assets, liabilities, income, and outflow.
The Four Pillars of Personal Finance
Thirty years ago, financial success was thought of in three pillars, not four: pension, social security, and personal savings.
As we all grow older and learn from our parents and grandparents, we understand that we cannot rely on the government to take care of us because it’s just too high of a risk.
Pensions are few and far between now, and personal savings accounts don’t earn much interest.
The responsibility falls on each of us individually to be able to have a plan and create the life we hoped for as we age.
To break it down, each person has their framework of personal finance. There are four main components: assets, liabilities, income, and outflow.
1. Assets
An asset is anything you own that can be turned into cash. It is something that contains economic value today or may in the future.
Some examples of assets are:
- house
- cars
- banks accounts (savings and checking)
- retirement plans
- artwork
- stocks
- fine jewelry
- land
- mutual funds
- cash value of a life insurance policy
- boats
Is My Car An Asset?
It is important to note that there is a difference between appreciating assets and depreciating assets. Things that go down in value are depreciating, and something that goes up is appreciating.
Most cars, boats, campers, motorcycles are depreciating assets because as time goes by, the amount that you can sell them for is less than what you bought it for.
According to experts, a good rule of thumb is the total value of cars and other things will a motor should not equal any more than half your annual income.
So, of course, if you make $100,000 a year, your cars, trucks, motorcycles, snowmobiles, and boats should not equal any more than $50,000.
Things like land, stocks, and your home tend to go up in value. These are the type of assets you want to invest in if you are looking to improve your net worth.
I would also like to point out that sometimes assets can be more of a liability. Consider not overextending yourself on these things, so you are not buried.
And always think long and hard about borrowing any money for these things as that will knock down your net worth quickly. Net worth is discussed below.
Why Are Assets Important?
Assets are valuable because knowing what you have and the value of them will give you a snapshot of what you have and how you are doing. These items will help you understand your net worth.
Also, if something were to happen and you needed money, assets will be quickly sold to give you fast cash.
Many times assets like rental properties, bank accounts, and investments can make you money.
The interest on checking and savings accounts as well as interest on 401K’s IRA’s and stocks will help you build wealth. Investment properties will bring in money each month to add to your income.
Assets can also assist you in a mortgage application. If you have assets worth a decent amount of money and you have not borrowed money to get them, those assets could help.
2. Debts or Liabilities
Debt is any money that’s owed to anyone else. If you borrow money from a bank or credit card company for a purchase, that is debt.
If you borrow money from Aunt Donna for the down payment on a house, that’s debt. If you are supposed to pay taxes to the government, and you have not, that’s also debt.
What is Debt?
So there are four different types of debt: secured debt, unsecured debt, revolving debt, and mortgages.
Secured Debt
Secured debt is when money is borrowed to purchase something. A credit check will be run to decide how much obligation you have and how well you are at paying it back. They call these secured debts because something is used as collateral for this loan.
For example, a car is a secured debt as it is secured by the vehicle. The bank will give you the money for that car but also puts a lien on the car.
If you do not pay that debt, the bank can take away that car or seize the asset – also known as repossession. The bank can then try to sell the car to someone else to recoup their losses.
Any type of asset that is purchased with a loan is a secured debt except a house. Mortgages are a little different, and I will explain that soon.
Unsecured Debt
Unsecured debt is any type of loan without collateral attached to it. Student loans, medical bills, and credit cards are examples.
The borrower is bound by a contract or written agreement, and if it is not paid, the lender may be able to take you to court to reclaim their money.
Going to court usually costs the lender money, so the most unsecured debt will come with a higher interest rate to cover those expenses.
Revolving Debt
Revolving debt is an agreement made by the lender and borrower to allow the consumer to borrow up to a certain amount of money.
Examples would be a credit card or line of credit. Revolving credit can be secured or unsecured. The credit card is unsecured, and the home equity line of credit secured.
Mortgages
Mortgages are their type of credit because of the size and years it takes to pay it back. Mortgages are the funding that one borrows to purchase a house or property.
It’s a secured credit that will typically take 15-30 years to pay back (with a lower interest rate) because of the large amount borrowed.
Why is it Bad to be in Debt?
Having debt is quite controversial. Depending on what expert you listen to will depend on whether there are differences between good debt and bad debt. And whether or not “good debt” is right.
Examples of “good debt.”
Some financial advisors will say that having a mortgage is good debt because you will get to write off the interest paid when you do your taxes.
In my experience, the little bit of tax credit I get is not enough to make me feel great about the bank holding that over my head. I would rather have the financial peace of owning my home outright rather than the small tax break.
Financial advisors will also tell you that any type of debt that accrues due to investing in yourself or your finances is good debt. Loans like student loans, home equity lines of credit, or small business loans are all considered “good credit.”
As a financial coach, I do not agree.
Mortgages are too large for most people to save up for. But if you can, by all means, go for it.
Any other type of debt will rob you of so much. The more obligation you have, the fewer opportunities you will get. If the house across the street goes up for sale for only $45,000 for some reason, if you have no debt and have a nice savings egg, you could purchase that home for a great rental property.
According to the Federal Reserve Bank of NY, 44.7 million people have student loan debt. Those payments are holding these people back from doing the things they want to do.
Some cannot afford to buy a house because these payments are as much as a mortgage payment. They can’t travel, start their own business, or quit their job to raise a family all because student loan debt hangs over their heads.
Why is debt bad?
As we stated above, debt will rob you of opportunities. Living your best life and making your dreams come true are all held back because you borrowed money from someone to have things you think you needed.
A little here and a little there, and before you know it, your buried and are taking back the bottles and cans to put gas in your car.
Saving up for things and only buying stuff if you have the money to do so will take a little longer. Come to peace with instant gratification.
Not only will debt hurt you right now, but it will also rob you in the planning of your retirement and decrease your net worth.
3. Income
Income is pretty self-explanatory, right? Its the money you make that “comes in” to your hands or bank account.
There are two types of income: fixed and variable.
Fixed is something that is about the same, and you can count on it at the same time and about the same amount each month. Examples of fixed income would be:
- reoccurring paychecks
- social security
- pension
Variable income would be money coming in but in staggering amounts of times. Some cases of varied income could be:
- bonuses
- equity
- commissions
- side hustle amounts
- selling something
Income and debt are significant parts of this personal finance structure. The more money you make, the faster you can get to those big goals. Unless you have too much debt.
It’s essential to know how much income it will take to support the lifestyle you want.
They both have a direct correlation to how quickly you can accumulate assets.
I was watching Youtube this week and have been very interested in watching people transform vans into small campers to travel.
This morning I watched a video about a woman who escaped corporate America to travel in a camper van. She ran the numbers and knew she only needed to make $1,000 a month to carry out her dream life.
If you are the type of person who wants to own a big house on the coast and drive fancy cars, you will need to have the proper income to support that lifestyle. Knowing this is a big part of the battle.
Then, don’t forget to save that money, so when you are too old and too sick to work, you have enough money to take care of yourself.
4. Expenses or Outflows
Just like income, there can be fixed and variable. Your rent or mortgage might be fixed, but your groceries and gas would be variable.
Most of the time, expenses can be flexible. Even fixed costs can change. You do not need to live in a pricey neighborhood or a part of the country that charges $2500 per month for a one-bedroom apartment.
There is always wiggle room in the variable expense category.
Saving at the grocery store is my jam, but cutting back on utilities, cooking at home, and meal planning, as well as all-around frugal living, are all ways to get those expenses low- as low as you feel comfortable with.
And then go a little smaller.
Limiting your expenses and living a life of frugality is what this blog is all about. Not only is it focused on getting out of debt, but saving money and frugal living all rolled into one so you can live the life you love and build your legacy.
All four of these pillars of personal finance will help you figure out your net worth. But…
What is Net Worth?
Net worth is how someone gauges how much they are worth. Businesses and companies need to evaluate this regularly. But individuals and families should also know this number as well.
Nerd Wallet has a great little calculator to figure this out, but you need some numbers first.
Net worth is your assets minus your liabilities.
This is a perfect way to look at your financial health, a money report card if you will.
For example:
Assets would be real estate, checking and savings accounts, retirement, cars, and others.
Liabilities would be a mortgage, consumer debt, personal loans, student loans, auto loans, and others.
Typing al of this into the calculator is a quick and easy way to see how you are doing at managing your money and to give you a direction to move in.
If you have a lot of debt and your dream is to have a million-dollar net worth, you can see how close you are getting with this money snapshot.
Final thoughts on the four pillars of personal finance and why they matter…
It is always a good idea to know where you are coming from and where you are going on your financial journey. Understanding the different legs of the table will give you a better grasp of your future.