Macro-Economic Factors and their Effect on Personal Finance
Personal finance is defined in such a way that it is supposed to be linked with the financial decisions of an individual or their family. Any decision which is taken at a higher level is not considered to be a part of the personal-finance domain. However, it is important to realize that decisions related to personal finance are not taken in isolation. These decisions are also influenced by the larger picture, i.e., the macroeconomic factors.
In this article, we will have a closer look at the interaction between personal finance and macro-economic factors.
Monetary policy is the tool used by the government to vary the amount of money supply in the system. The decisions made by the government here can have far-reaching impacts on the personal finance decisions being made by individuals as well as families. When the government increases or decreases the interest rate, it basically influences the collective saving decisions of millions of families in the nation.
A lower interest rate often gives an impetus to consumption, and hence it has been observed that a lower interest rate also correlates with a period wherein the savings rate is also low. In such times, people are discouraged from making savings since the outcome of savings is not that rewarding.
Fiscal policy is related to tax receipts as well as expenditure is done by the government. The fiscal policy of a country impacts the common man largely because it impacts the manner in which the common man is taxed. For instance, if the government decides to lower their budget, then they reduce several taxes that are levied on common people. Lower taxes mean that people will have more disposable income on their hands.
A higher disposable income could mean more savings. Also, the government can influence the prices of different asset classes with its taxation policy. For instance, in many parts of the world, governments provide a tax break to people who invest in real estate. As a result, the asset class becomes more attractive for many people. Hence, larger than usual investments are routed to real estate. Similarly, in many parts of the world, earnings from the stock market are not taxed if they are held for over long periods of time. In such countries, people prefer investments in equity assets more than investments in other asset classes.
In some countries, governments have welfare-oriented policies. For instance, in countries like Canada and the United Kingdom, governments provide health care benefits to the people. In such countries, individuals do not feel a need to purchase insurance policies in their own capacity.
Hence, financial planning is taken care of at a collective level. Similarly, in many parts of the world, particularly in Scandinavian countries, college education is free. Hence, in these parts of the world, people do not have to set aside money for their kids college education. This is completely different as compared to countries like the United States, wherein college education is the second most common goal in financial planning after retirement.
Business cycles such as boom, recession, depression, etc., also have a huge impact on the way in which individuals and families plan their finances. For instance, in periods of recession and depression, liquidity is extremely important. This is the reason that people do not want to lock their investments in long term investments. There is always a fear of loss of income, and hence people might want to dip into their savings at any given point in time. This makes them prefer liquid investments. Similarly, in the time of boom, people tend to become riskier. This is because they have a higher income and also a higher level of confidence. Both of these factors make them more comfortable with risk-taking.
The level of inflation present in an economy has a massive impact on the financial planning process for individuals. This is because inflation has an impact on both aspects of financial planning. On the one hand, when inflation increases, the costs of goods and services increased, and the entire budget goes for a toss. This is the reason that people are left with less money to save. This lower savings rate lowers the amount of corpus that they are able to build over their productive life. On the other hand, a higher inflation rate also means that the corpus which has been saved by the investor may be inadequate to get them through their retirement.
For instance, if a person saves $5 million today, they might be able to live comfortably off the interest today. However, if inflation rises rapidly, then people will not be able to lead a comfortable life since the real value of $5 million would have declined over the years. Therefore, people who actually live in countries where there is a lot of inflation need to save and invest more aggressively. Also, they need to allocate a portion of their portfolio to investments such as gold, which have traditionally acted as a hedge against inflation.
The bottom line is that the macro factors do have a huge impact on the micro. In fact, most of the time, when adjustments have to be made to personal financial plans, it is because of the unforeseen impact made by the macro factors. A good financial planner ensures that macro-economic factors are also taken into account before making a financial plan.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Importance of Personal Finance
- Process of Financial Planning
- The Financial Life Cycle
- Three Types of Income
- Misconceptions about Personal Finance
- Macro-Economic Factors and their Effect on Personal Finance
- Going From Financial Goals to a Financial Plan
- Components of a Financial Plan
- Personal Financial Statements
- Advantages and Limitations of a Budget
- Ratio Analysis in Personal Finance
- Dollar-Cost Averaging
- Pitfalls of Dollar-Cost Averaging
- Value Averaging Method of Investment
- The Rent vs. Buy Decision
- Financing Your Home
- Fixed-Rate Mortgage vs. Adjustable Rate Mortgage
- The Phenomenon of House Poverty
- 5 Step Retirement Planning
- Retirement Basics: 401K Plan
- Retirement Basics: Roth IRA
- Auto Loans and Personal Finance
- Earnings Power in Personal Finance
- Personal Financial Planning For Small Businesses
- Common Pitfalls of Tax Planning
- Zero Based Budgeting System Using Envelopes
- The Concept of Financial Freedom
- The Financial Independence Retire Early (FIRE) Movement
- How Do People Save Large Percentages of Their Income?
- Rich Dad Poor Dad Philosophy
- The Pay Yourself First Principle
- Personal Finance Lessons from Rich Dad Poor Dad
- Estate Planning in Personal Finance
- 7 Personal Finance Mistakes to Avoid