At its core, personal finance is very simple. There *is* a knowledge bar, but the majority of personal finance comes down to behavior and execution. That’s right – for all of the words written about the subject, there are exactly four pillars of personal finance.
The Four Pillars of Personal Finance
Before we get to the pillars, there are two concepts that matter to your finances: your current stocks and flows.
Stocks are things you have now: how much water there is in the bucket. Flows are the rate things are changing: how quickly water is flowing into or out of the bucket.
The two stocks that matter to your financial security are your assets and debts. Likewise, the two flows that matter are your inflows (usually income) and outflows (spending).
Let’s address the four pillars of personal finance in order.
When we talk about personal finance, assets are anything you can convert into money.
Houses, stock, bonds, mutual funds, cars, silverware, rare guitars, cash – all of these things are assets. While each one differs in liquidity – that is, how long it would take to turn into cash – each does have monetary value.
Assets are also one of the two inputs to net worth. When you subtract debt from assets you are left with net worth, or the liquidation value of everything you own.
Debts are whatever you owe to outside entities.
Maybe you have a mortgage, credit card bills, student loans – all of these things have a cash value. In other words, they would cost a certain amount to eliminate completely.
Again, you have freedom with the due dates on most of your debts – they aren’t all due in full next month. However, in a full accounting of net worth you look at the full cost to eliminate your debt (principal).
Inflows are the rate of change of money flowing into your bucket.
For many people, inflows are mostly recurring income. That might be a steady paycheck, or benefits from a company or government such as matching funds, a pension, or even Social Security.
Others will have more variable pay through equity, bonuses, or commissions.
Sometimes people will experience lump sum payments (also known as an event in shorthand) such as the sale of a business or house.
Although paychecks and some benefits payments are steady, other cash flows such as variable pay – and especially events – are spiky. When we talk about inflows we usually bucket them into a specific time frame. Think: dollars per month or dollars per year.
Either way, inflows speak to how quickly you’re accumulating more assets.
Outflows are simply how quickly you are spending money.
As the inversion of inflows, these can also be steady or variable. Steady expenses are things like rent or a cable subscription. Variable expenses might include restaurant meals and travel. Expenses can also be events – vehicle or home purchases, tax payments, and emergencies to name a few.
Once again, because outflows can be spiky, it’s best to smooth them out by quoting them over time periods. ‘Average expenses per month’ or ‘per year’ are the most common ways to quote outflows.
Summarizing the Four Pillars with the Two Equations of Financial Security
There are four pillars of personal finance : assets & debts, and inflows & outflows. They, respectively, sit in the stock and flow bucket.
We summarize those two buckets with special equations: one for net worth, and one for cash flow. These map to stocks and flows respectively.
Net Worth = Assets – Debts
Cash Flow = Inflows – Outflows
As we said – personal finance is very simple. If your inflows continue to outpace your outflows, your net worth will increase. If you spend too quickly and have to take on debt, your net worth will decrease. Everything is intertwined, but these are the only four things you need to worry about.
As for strategy, it’s simple: increase your monthly cash flow and increase your net worth. Net worth is, in many ways, the ultimate number: it takes time to turn cash flows into net worth, but you can buy cash flow using net worth.
Does that clarify how easy personal finance really is? We hope so.
If you’re ready to dive into the weeds, we wrote up everything you need to know about the details of personal finance here.