How to master the basics of personal finance

Managing unexpected expenses or navigating a pay raise are essential skills for maintaining financial security.

A person’s financial situation is rarely stable for long, and gaining a better understanding of the fundamentals this Financial Awareness Day on August 14 can significantly improve your wealth-building potential.

It is important to remember that if you are unfamiliar with a specific topic or are struggling with your finances, there is plenty of support available, including organizations like StepChange for debt advice and the Just Finance Foundation, which focuses on improving financial literacy.

For the most part, people may struggle with money simply because they were never provided with the necessary tools to succeed—whether through early education or later guidance on complex topics like investing or understanding purchasing power.

“Financial Awareness Day isn’t about shaming people for short-term budget struggles or forcing anyone to sit through an overwhelming maths test. It’s about taking back control of your own future,” says Susan Hope, Retirement Expert at Scottish Widows.

So how do you take back control, and master the basics of personal finance?

To gain a clearer picture of your financial health, you must categorize your money into different areas.

“Start off by understanding the basics of saving, budgeting, investing, and retirement planning,” suggests Ms Hope.

Budgeting must come first, as it establishes the limits for everything else.

To budget effectively, you need to know exactly how much money is coming in, whether it originates from a salary, benefits, pocket money, side-hustle earnings, or later-life income such as dividends, rental payments, or pensions.

From that starting point, you can determine your spending habits and categorize them into different areas, such as needs versus wants, or monitor your expenses over specific timeframes.

“Think about how to make budget tracking work for you. Do you want to have a weekly limit, or a monthly one? Would you want to allocate a certain amount for different uses, like eating out or shopping? This will help you figure out where your money is going, and whether you need to make any changes to cut costs,” explains Duncan Fortune, head of commercial at Tesco Bank.

There is no single correct way to budget; explore various common approaches to see which fits your lifestyle and your ability to remain consistent.

Any effective budget should allow for some discretionary spending. After all, what is life without a little enjoyment?

However, it should also include a portion of cash diverted toward savings. There are three primary types to consider.

First, build an essential emergency fund to cover unexpected bills for urgent needs. Next, save for specific goals, such as holiday gifts or a vacation with friends. Finally, focus on long-term savings, which might include a house deposit or other major milestones.

Keep your savings separate from your everyday spending money. Many people now maintain individual savings pots for different purposes, ensuring that when you book that holiday, you know exactly how much you can afford to spend.

A final important note: ensure your savings are earning a competitive interest rate, as this is what helps your money grow.

Understanding compounding and inflation will not only simplify your financial life over the long term, but it will also put you ahead of the national average, according to most financial literacy research.

Compounding is essentially the process of earning interest on the money you have already earned.

For example, if you have £1,000 in savings and earn 4 per cent interest, you will earn £40 over the year. If you repeat this the following year, you will earn 4 per cent on £1,040, which equals £41.60. In other words, you have received an extra £1.60 by earning interest on your interest, rather than on any additional contributions. This is compounding in action.

While this may seem insignificant on a small scale, it is the single most powerful tool at your disposal over years and decades. Learn how to maximize it to your advantage.

As for inflation, it works in the opposite direction: it is the process by which your purchasing power is eroded year after year by rising prices.

While the causes of inflation are a complex topic, you can beat it by ensuring your savings interest rate stays above the rate of inflation—this is known as growing your cash in real terms.

Research from LV shows nearly half (45 per cent) of UK adults are not confident they’ll be financially better off in five years’ time.

Get the basics in order—budgeting, saving, and understanding how to grow your money—and you are already ahead. Use these habits to maintain control of your finances with occasional check-ins, and you should feel confident in your ability to improve your situation materially.

For the longer term, there are two primary ways to ensure greater financial resilience: investing and pensions (though pensions are generally invested, we will treat them separately here).

If you have built up your savings and still have spare cash that you will not need for at least three years—ideally much longer—you could consider investing. Over time, investing typically provides better returns than saving alone, as stock markets can grow at higher rates than standard bank interest.

Conduct your investing within an ISA so that any growth or dividend payments remain tax-free, and you can sell your investments to access funds if necessary.

Pension contributions are different; you cannot access them until retirement age, but that does not mean the money is gone. In fact, due to the effects of compounding, it is one of the most effective ways to build a retirement fund.

You can manage this yourselfp your state pension, or contribute a portion of your salary into a workplace pension, where your employer often adds a matching contribution

If you are employed, check if your employer offers to match your contributions—if so, that is effectively free money. If times are tight, reducing your pension payments briefly rather than stopping them entirely can make a significant difference in the long run.

“If you’re facing financial difficulties, consider reducing your contributions rather than stopping them altogether – even small contributions are better than none, and you’ll still benefit from your employer’s contributions,” says Ms Hope. “Don’t miss out on the ‘free money’ that your company adds to your pot!”

Pension and investment planning can sometimes seem intimidating because people assume they need a large sum to start, but most platforms now allow you to begin with as little as £25 or £100.

Build your balance month by month, using small amounts if necessary, and you will be adding significant layers of improvement to your overall financial picture.

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.