12 common personal finance questions, answered
Everyone has personal finance questions, but some shy away from finding the answers because it’s just too complicated to think about. We’ve put together this simple guide based on common personal finance questions people search for on the internet, as you may wonder about many of the same things.
So, take a look at these 12 questions and answers that can help you feel more confident about your financial decisions. After all, it’s never too late to learn about best practices for personal finance – and start experiencing the confidence that financial wellness can bring.
1. Is your emergency fund sufficient?
Financial professionals typically suggest having an emergency fund that can cover three to six months' worth of living expenses. In the past few years, these numbers have increased, with financial gurus suggesting six to twelve months is needed to ensure a solid financial cushion. Having extra money set aside can provide a sense of confidence in case of sudden job loss, medical emergencies, or other unexpected expenses, and helps prevent the need to incur debt. In any case, the exact amount will vary depending on individual circumstances such as your lifestyle, monthly costs, income, and dependents, as well as your comfort level with risk.
Additional considerations, such as disability insurance, can act as a protect should you become unable to work due to sickness or injury by replacing a portion of your income so you can pay your bills. That's why many financial professionals say it's worth considering disability insurance as part of your overall financial protection strategy.
2. What does it mean to create a personal budget?
Creating a personal finance budget involves determining your financial goals and then outlining the monthly, quarterly, or even annual income, expenditures, and savings you will need in order to achieve these goals. A budget aids in monitoring cash flow, restricting overspending, reducing credit card debt, and ensuring funds are allocated appropriately. It is an essential tool for financial security and planning, assisting in debt reduction, building an emergency fund, providing financial protection (such as through life or disability insurance), and gradually building retirement savings.
3. Is life insurance important?
In a word – yes. If you have loved ones who depend on you for support — financial or otherwise — obtaining life insurance can help ensure they’re provided for financially. Even if you don’t have dependents, life insurance can be used to help build tax-advantaged family assets, help ensure the continuity of your business if you pass away, or even pay for final expenses.
Did you know that over two-thirds of adults overestimate the cost of life insurance? If you’ve ever wondered how much life insurance you need – and what it might cost – try this life insurance calculator to get an answer in just a few minutes.
4. I want to purchase a home. What do I need to do to make the process go smoother?
Start by reviewing your budget to understand exactly what you can afford, considering not only the payments due based on current mortgage rates but also property taxes, insurance, and maintenance costs. Also, consider building up your emergency fund to cover unexpected expenses that often arise with home ownership.
Next, check your credit report. How can a mediocre or poor credit score affect the homebuying process? Even if your income is above average, a below-average credit score can make it harder to get a mortgage approval and secure a good interest rate. So, if needed, take some time to improve your credit by paying down debts and ensuring you pay all your bills on time.
Start saving for a down payment as early as possible. The larger the down payment, the smaller the loan you'll need to take out and the less interest you'll end up paying over time. Finally, do lots of homework. Understand the current real estate market, research prospective neighborhoods, and consider your long-term plans. Working with a trusted real estate agent or financial professional can provide valuable insights on how to get the right house while keeping mortgage payments affordable.
5. How do I save for a house?
Begin by determining what type of home you would like to buy and its estimated cost so you can set a savings target. A down payment is typically 20% of the home's price, though it can be lower depending on your mortgage type. For example, if you served in the armed forces, you should try to get a VA loan that lets you buy a house with a $0 down payment. You should also factor in "closing costs" – various taxes and fees that can total as much as 2%-5% of your loan amount – although some of these costs may be rolled into your mortgage and paid for over time.
Create a budget, then track your income and expenses. Be as dogged as possible about finding ways to save – and be consistent about it. Consider automating your savings, i.e., having a specific amount directly transferred from your paycheck to a separate savings account. And if you get any raises or bonuses, apply as much of that money as possible to your savings.
6. What is a credit score, and how is it calculated?
A credit score is a numerical formula used by lenders (such as banks, finance companies, and credit card issuers) to assess your creditworthiness. Based on a thorough analysis of your credit files and history, the score aims to quantify the “credit risk” associated with providing you with a mortgage, car loan, or personal loan: The higher your score, the more you’re considered creditworthy.
Credit scores are calculated using a complex formula that evaluates several types of financial data, such as payment history, credit utilization ratio (debt to credit), length of credit history, credit mix (credit cards, various loans, etc.), new credit inquiries, and more. Each of these factors is weighted to produce your credit score, and you can review exactly how your credit score was calculated by getting your credit report. There are a number of steps you can take to improve your score. For example, always pay bills on time; if you are carrying a balance on a credit card, try to avoid making only the minimum payment; and if you have any bank accounts with a minimum balance requirement, be sure to keep your balance above that level.
Credit scores and credit reports are issued by three major bureaus: Equifax, Experian, and TransUnion. The average credit score in the U.S. for 2022 was 714. Anything above 700 is generally considered a good credit score; anything below 580 is usually considered a poor credit score.
7. How much do I need to save for retirement?
No one knows how long they will live, so it's impossible to know exactly how much money you will need to set aside in a retirement account. However, there are several factors to consider, such as your present income and savings, the age at which you plan to retire, the lifestyle you expect to have, a spouse or beneficiaries you will need to support, and what you think your Social Security benefits and other future income sources will be. This retirement calculator can help you assess your situation and see where you stand.
But keep in mind – you may have more assets than you realize. For example, if you have a whole life insurance policy, it builds tax-advantaged cash value over time, and you can access those funds during your lifetime for things such as buying a home, paying for a child's college education, and, importantly, supplementing your retirement savings.
8. How much money do I need to start investing?
There's a common misconception that you need a large sum of money to start investing. That’s not necessarily the case anymore: new financial apps and online platforms have made it possible to buy fractional shares, allowing you to become a market investor with just a few dollars.
Having said that, you should look at investing as a long-term strategy. All investments involve some level of risk, and the value of stocks and even bonds can go down, at least in the short term. So it's critical to consider your financial stability before embarking on an investment strategy. You want to avoid being in a position where you're forced to sell holdings at a loss due to a sudden expense. It's advisable first to establish an emergency fund and pay off high-interest debt. And once you're ready to start, it's always good practice to learn about investing from a reliable source or speak with a financial professional to help guide you. The more knowledgeable you are about investing, the less likely you are to make avoidable mistakes.
9. How much do I need to save for my child’s college?
The amount of money you need to save for a college education depends on several factors, including the type of school (public vs. private), increases in tuition fees, and your child's age. For instance, according to the College Board, the average 2023-24 tuition and fees for a state resident at a four-year public college is $11,260 per year, while for private colleges, it's $41,450.
However, these figures don't include living expenses, books, or other fees. If your child is still young, you'll also need to account for inflation, even though there's some evidence that the upward trend in college costs is slowing: this report also shows that the average college tuition increased less than inflation for 2023-24, for the third year in a row.
Speaking with a financial professional can help you set realistic savings goals and choose the appropriate savings plan, like a 529 college savings account.
10. How do I finance a big purchase?
Begin by assessing your current financial situation, including your savings, income, and existing debt. Next, consider the cost of the item and decide how much you can afford to pay upfront. The remaining amount is what you'll need to finance. Look at various secured and unsecured loan and financing options, such as a home equity line of credit (HELOC), personal loan, credit cards, or store financing (i.e., a retail loan) – and compare interest rates and terms for each.
Keep in mind that while financing can make a large purchase more manageable by spreading the cost out over time, it also adds to the total cost of the item due to interest and fees. So, you should generally aim to pay off the debt as quickly as possible to minimize these additional costs. One exception: if you locked in a mortgage with low-interest a few years back, and can currently earn a guaranteed savings rate higher than your mortgage rate, you may come out ahead by saving any extra cash instead of paying down your mortgage principal.
11. What are the five basics of personal finance?
Personal finance is about how you make, manage, and save money through budgeting, investing, and more. However, everyone is different; certain topics are more relevant to some people than others. Having said that, many financial professionals consider the five basics of personal finance to be:
Income: This is the money you earn, including salaries, wages, dividends, and other sources of cash inflow. It's important to have a clear understanding of your total income as it forms the basis for budgeting, saving, and investing.
Spending: This refers to how you use your income to meet your basic needs and wants, including rent, mortgage, groceries, hobbies, eating out, home furnishings, home repairs, travel, and entertainment.
Saving: This represents the portion of your income you set aside for future use, including emergency funds. Investopedia recommends allocating between three and 12 months of expenses as savings to meet any fluctuations in income and spending.
Investing: This is the practice of putting your money to work through the purchasing of assets, including stocks and bonds, to earn a return on your money. Investing wisely can be a powerful mechanism for wealth generation.
Protection: This refers to precautions you take to protect your assets from financial loss. It could include insurance products such as health insurance, homeowners insurance, and life insurance, which provide protection against unforeseen and potentially financially devastating events.
Remember, personal finance is highly individualized. It's a good idea to consult with a financial professional for guidance that’s right for your situation and goals, and regularly review and adjust your plans as your life circumstances change.
12. What are the five financial literacy questions?
Financial literacy refers to the level of knowledge and understanding you have about personal finance. A high level of financial literacy means you have the tools and skills to understand how to budget, save money, and make smart investment decisions to help your dollars go further for you.
While there is no definitive test of financial literacy, certain organizations have created lists of basic financial literacy questions to help people identify areas in which they may need more education to round out their financial knowledge. Here is one such list from the Global Financial Literacy Excellence Center.