The process of money management and budgeting should focus on maximizing return and value while minimizing risk and controlling expenses. This process should typically begin with a review of personal finances, expenses, and debt, with the goal of establishing a positive cash flow for investment while meeting everyday needs. Once money has been found for investing, that money should be invested using a diversified investment strategy with appropriate levels of risk and return.
A personal budget can be a very useful tool in managing personal finances. Many people are unaware of the exact structure of their personal economic lives, and do not actually know how much they earn or where and how they spend their money. Keeping careful records of income and expenditures allows for a much more accurate process of money management and budgeting. Purchases should be budgeted and planned for, and future expenses should be anticipated. If a homeowner knows that the roof of his or her house has passed out of warranty and is showing signs of wear, he or she should set aside funds to cover this anticipated expense.
When determining how to allocate money in a budget, several rules can be helpful. First and foremost, it is essential to preserve some liquid assets, usually in deposit accounts, to allow unexpected expenses to be covered. Credit can be used for this purpose, but this can be a dangerous practice if that credit cannot then be paid down. Once a cushion has been established, money management and budgeting should be focused on finding the highest effective rate of return. Often, this involves paying down debts before purchasing investments.
After high-interest debt has been paid off, the next step in money management and budgeting should be the selection of an appropriate investment portfolio. As a general rule, no portfolio should focus entirely on high-risk investments such as stock purchases. Typically, a portfolio should contain a mixture of investments in different sectors, but each investor should assess his or her personal long-term financial goals, with an eye on both risk and return. Usually, riskier investments offer higher rates of return but may lose some or all of their value. A diversified approach to money management and budgeting allows an investor to secure a high rate of return on some assets without risking the entirety of his or her portfolio.
Certificates of deposit and investment-grade bonds are typically very safe investments. Junk bonds, penny stocks, and futures contracts are often much riskier, especially for casual investors, but can pay high rates of return. Government bonds, carefully-selected stock investments, and many mutual funds occupy a middle ground where risk and reward are both moderate. Typically, it is a wise idea to shift gradually to a more conservative asset allocation in the years leading up to the event that a set of investments is designed to fund, whether that is a college education or a retirement, to avoid the possibility of a temporary drop in asset prices.