Finance is the science of funds management. This includes all the processes by which an individual or a household creates, maintains, controls, and uses funds. Finance is also used to define a number of other related subjects such as money management, budgeting, investment, taxes, saving, investing, estate, and financial counseling. The word often refers to the whole field that offers financial advice to families and individuals and advises them on financial issues.
There are three major areas of personal finance: budgeting, investing, and saving. Budgeting covers how you spend your money every month. It includes things like how you shop for food, clothes, shelter, transportation, entertainment, and home-related needs. In contrast, saving involves saving for unexpected expenses and possible future costs such as education, medical expenses, or insurance. All three have to do with controlling spending and reducing debt. There is also the discipline aspect of saving for the future, retirement, and insurance for loved ones.
Investing refers to putting your money to work for you in the form of stocks, bonds, mutual funds, real estate, and insurance. With saving, your focus is more on liquid funds than savings. You may also include interest payments on credit cards, loans, and mortgage payments in your list of expenses. While investing, you want to make sure you have enough liquid cash flow so you can take advantage of any opportunities to earn money quickly.
Investing involves creating a specific investment portfolio that consists of both savings and investment options. The investment options could be government bonds, stock funds, mutual funds, certificates of deposit (CD), and money market funds. The objective is to create an environment where your money grows with interest, and at the same time, it is not susceptible to market volatility. For example, it is possible to invest for a long period of time in the money market without ever experiencing a market decline, whereas saving only handles short-term fluctuations in income.
Both long-term investing and saving involve evaluating how the value of money changes over time. Long-term investing focuses on the expected rate of return and how the value of the fund’s assets will change over time. Savings involves evaluating how the interest on an investment will be used and how the amount of the interest will impact the final cost of ownership of the investment portfolio. Most people save for retirement and make sure there is enough money available for their retirement needs before they retire. As with all long-term investing decisions, it makes sense to evaluate the pros and cons of any particular investment option.
Although savings and investing are similar in many ways, there are some differences between the methods. Savings accounts generally carry less interest than mutual funds. Long-term investing involves carrying a cash reserve for emergencies and disaster situations. It does not make sense to close your emergency fund while you are young, as it is much easier to access it during emergencies.