Managing Personal Finances: Overview
Created by FindLaw's team of legal writers and editors | Last reviewed June 20, 2016
Financial management is an important part of financial planning. When managing personal finances, having
a clear objective and knowledge about one's finances is an essential part of creating a workable plan that is
right for you. Financial management involves creating a budget, choosing a bank, paying taxes, managing
debt, investing, retirement planning, and estate planning.
Assess Your Financial Situation
Determining one's net worth is an important element of managing personal finances. By assessing net
worth, it is possible to place a monetary value on one's financial situation. Financial assets include:
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money in a bank account
stocks
bonds
mutual fund accounts
retirement accounts
future income expected from Social Security benefits and pension plans
the value of a business or real estate investment
a personal residence, if the property will be sold or the money invested in it will be used to pay for
living expenses in the future
Items such as cars and clothing are generally not included since it is impossible to live off them unless sold
for their cash value.
Financial liabilities include:
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car loans
mortgage on a personal residence if the home was included as an asset
mortgage on investment real estate
student loans
credit cards
personal loans
Determine net worth by subtracting total liabilities from total assets. This information will help evaluate
overall financial health.
Create a Budget
To manage personal finances effectively, it will require creating a budget. A budget is a plan used to track
income and expenses. A budget is also a good way to set financial priorities like saving for retirement or a
vacation and managing debt. Creating and maintaining a budget is easy to do with a software program
such as Quicken. Financial software programs allow the user to create a budget and to track income,
spending, debt management, and financial goals.
Choose a Bank that is Right for You
It is important to choose a bank that will help you accomplish your financial goals. Be aware that some
banks charge more fees for some services than other banks. For example, a number of banks charge fees
for account maintenance, teller services, ATM usage, overdraft protection, and online bill paying.
Many banks will waive some fees if the customer meets certain criteria, such as having a paycheck directly
deposited into a checking account or keeping a minimum balance in a savings account. When selecting a
bank, it is important to consider whether the account provides unlimited check writing, whether most
banking transactions will be conducted face-to-face, or whether overdraft protection is necessary. Also,
note whether the bank offers fraud protection. Many banks offer zero-liability protection for fraudulent
charges made on a debit card.
Pay Taxes
Paying taxes on time is an important part of managing personal finances. If self-employed, it may be
necessary to pay estimated taxes throughout the year. Filing a tax return by the deadline will avoid the
payment of costly penalties. Taxpayers that are unable to file a tax return on time can obtain an extension.
The extension, however, does not extend the time allowed to actually pay the taxes owed.
Manage Debt
It is important to take control of debt. Although most people have some kind of debt, such as a car loan or a
mortgage, high interest debt can lead to disastrous consequences. Warning signs of too much debt include
only making the minimum payment every month, making late payments, having at least one credit card that
is near its credit limit, and taking cash advances to pay bills. To get control over debt, an individual can sell
investments, negotiate with a creditor to repay the debt in a payment plan, or file for bankruptcy.
Keeping debt low is also an important component of an individual's credit score. While making payments on
time is the most crucial factor, the second most critical factor is the total amount of debt owed. A debtor can
improve a credit score by paying down debt and by refraining from incurring any more debt.
Invest Your Money
Part of financial management includes a plan to generate income from investments. Investing is a good
way to generate income through compound interest and capital gains. Investments, however, only make
sense when an individual is debt-free or has a small amount of debt at a low interest rate. Depending on
the level of risk that is personally acceptable, investment choices include certificates of deposit (CDs),
bonds, mutual funds, real estate, commodities, stocks, and business ventures.
Each type of investment has a different level of risk and offers a different return on the investment. For
instance, because stocks have a higher level of risk than a bond, the return is typically higher. Choose a
type of investment that meets the level of risk that is most comfortable.
Plan for Retirement
Planning for retirement is essential to ensuring a comfortable life in the future. Investing in an employersponsored retirement plan like a 401(k) is a good way to save for the future, reduce tax liability, and earn
tax-deferred growth. Some employers will even match contributions.
An IRA account is another way to invest for retirement. Like a 401(k), the earnings are tax-deferred, and, in
some circumstances, contributions to an IRA are eligible for a tax deduction.
Plan for When You Die
Estate planning is another essential aspect of managing personal finances. A will can ensure that property
and cash are dispersed to the appropriate heirs. An individual with minor children will also want to use a will
to appoint a guardian to care for their children if they die. Also, consider using a living trust to designate
property to specific beneficiaries. A living trust is beneficial because it is not subject to probate and can
reduce estate taxes.
Personal Finance
Personal finance is a term meant to describe managing your finances through budgeting, spending and
savings. This involves long-term planning and considers potential financial risks, retirement and estate
planning, investments and how your financial situation evolves over a lifetime.
Why Is Personal Finance Important?
Personal finance is a vital part of not only managing your day-to-day financial needs but also planning your
financial future. The sooner you get a grip on personal finance, the better your long-term financial prospects
will be for things like investing or planning for retirement.
What Are the Five Areas of Personal Finance?
Though there are several aspects to personal finance, they easily fit into one of five categories: income,
spending, savings, investing and protection. These five areas are critical to shaping your personal financial
planning.
Five Aspects of Personal Finance
Income
Income is the foundation of your personal finances and includes all parts of your cash flow – the money you
take in from all sources. It includes your salary, pension or Social Security, income from rental properties or
investments.
Spending
Spending includes the money for any expenses you have. Controlling the amount of money you spend can
allow you to set aside money to grow your financial future.
Savings
Savings includes any money from your income that you do not spend but set aside for the future. It is
necessary to provide for potential expenses – planned or unplanned.
Investing
Investing is different from savings. While savings are what’s left over from your income, investments are
purchases that allow you to earn future income or savings. Investments may include purchases of mutual
funds, stocks, bondsor real estate that you expect to give you a good rate of return. But investments come
with risk.
Protection
Protection from financial risks can be handled through a variety of financial products including annuities,
property/casualty insurance, life insurance and health insurance. These can provide financial security or
protection from unexpected financial costs.
References
What Are the Fundamental Principles of Personal Finance?
There are 12 basic principles of successful personal finance, according to the Jump$tart Coalition for
Financial Literacy, a nonprofit organization that promotes financial literacy education in U.S. public schools.
Though designed to teach school kids the basics of financial literacy and responsibility, the principles have
been used for more than two decades to guide adults toward better personal finance practices as well. And
they hold up at any stage of life.
The 12 Principles of Personal Finance
Know your take home pay
Be aware of your income before you commit to any significant spending such as credit card debt, car loans
or a mortgage.
Pay yourself first
Set aside money from each paycheck for unexpected emergencies and long-term goals before paying your
bills.
Start saving now
Ideally, you should start saving for your future while you’re still young. The longer you save, the more
interest your savings will earn.
Compare interest rates
Whether it’s saving for your future or looking for the right credit card, look for the best interest rates first to
earn more interest on savings and pay less interest on debt.
Remember the “Rule of 72”
To figure out how many years it will take your savings to double, divide 72 by the interest rate of your
savings.
Never borrow what you can’t repay
Make sure you can pay off what you owe. This will improve your credit overall and keep your debt
manageable.
Create a budget
Set up an annual budget of income and known expenses. Use this as a roadmap to build your savings
while living within your income.
Remember that high returns mean high risks
High return on investment typically means you are going to have to take higher risks. Diversifying your
investments can spread that risk around, protecting your investments.
Don’t expect something for nothing
Be wary of get-rich quick schemes. If they were real, everyone would already be doing them. If it sounds
too good to be true, it probably is.
Plan your financial future
Take time to write down your financial goals – both short-term and long-term. Then work out a realistic
roadmap to get you to those goals.
Your credit past determines your credit future
Your credit record is kept for years by credit bureaus. If you have trouble paying loans or credit card debt,
that record will hurt your chances of getting credit in the future.
Buy insurance
Health, auto, home and life insurance can protect you and your loved ones from financial hardship in the
event of accidents or illness.
How to Become Better Educated at Personal Finance
There is a wealth of resources available online, from nonprofit organizations and state and local
governments for people who want to learn more about personal finance.
In addition, there are online and in-person classes available – often for a fee – from for-profit organizations
and educational institutions.
What Is Money? Definition, History, Types, and Creation
By
The Investopedia Team
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Updated November 30, 2022
Reviewed by Caitlin Clarke
Fact checked by Jiwon Ma
Money is any item or medium of exchange that is accepted by people for the payment of goods and
services, as well as the repayment of loans. Money makes the world go 'round. Economies rely on money
to facilitate transactions and to power financial growth. Typically, it is economists who define money, where
it comes from, and what it's worth. Here are the multifaceted characteristics of money.
Money
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From Wikipedia, the free encyclopedia
For other uses, see Money (disambiguation).
A United States dollar bill, two five-cent coins and a penny
A sample picture of a fictional ATM card. The largest part of the world's money exists only as accounting
numbers which are transferred between financial computers. Various plastic cards and other devices give
individual consumers the power to electronically transfer such money to and from their bank accounts,
without the use of currency.
In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with
the beggar whose legs and arms were amputated, in the left corner.
Money is any item or verifiable record that is generally accepted as payment for goods and services and
repayment of debts, such as taxes, in a particular country or socio-economic context.[1][2][3] The primary
functions which distinguish money are as a medium of exchange, a unit of account, a store of value and
sometimes, a standard of deferred payment.
Money was historically an emergent market phenomenon that possess intrinsic value as a commodity;
nearly all contemporary money systems are based on unbacked fiat money without use value.[4] Its value is
consequently derived by social convention, having been declared by a government or regulatory entity to
be legal tender; that is, it must be accepted as a form of payment within the boundaries of the country, for
"all debts, public and private", in the case of the United States dollar.
The money supply of a country comprises all currency in circulation (banknotes and coins currently issued)
and, depending on the particular definition used, one or more types of bank money (the balances held in
checking accounts, savings accounts, and other types of bank accounts). Bank money, whose value exists
on the books of financial institutions and can be converted into physical notes or used for cashless
payment, forms by far the largest part of broad money in developed countries.
Etymology
The word money derives from the Latin word moneta with the meaning "coin" via French monnaie. The
Latin word is believed to originate from a temple of Juno, on Capitoline, one of Rome's seven hills. In the
ancient world, Juno was often associated with money. The temple of Juno Moneta at Rome was the place
where the mint of Ancient Rome was located.[5] The name "Juno" may have derived from the Etruscan
goddess Uni (which means "the one", "unique", "unit", "union", "united") and "Moneta" either from the Latin
word "monere" (remind, warn, or instruct) or the Greek word "moneres" (alone, unique).
In the Western world a prevalent term for coin-money has been specie, stemming from Latin in specie,
meaning "in kind".[6]
History
Main article: History of money
A 640 BC one-third stater electrum coin from Lydia
The use of barter-like methods may date back to at least 100,000 years ago, though there is no evidence of
a society or economy that relied primarily on barter.[7][8] Instead, non-monetary societies operated largely
along the principles of gift economy and debt.[9][10] When barter did in fact occur, it was usually between
either complete strangers or potential enemies.[11]
Many cultures around the world eventually developed the use of commodity money. The Mesopotamian
shekel was a unit of weight, and relied on the mass of something like 160 grains of barley.[12] The first
usage of the term came from Mesopotamia circa 3000 BC. Societies in the Americas, Asia, Africa and
Australia used shell money—often, the shells of the cowry (Cypraea moneta L. or C. annulus L.). According
to Herodotus, the Lydians were the first people to introduce the use of gold and silver coins.[13] It is thought
by modern scholars that these first stamped coins were minted around 650 to 600 BC.[14]
Song Dynasty Jiaozi, the world's earliest paper money
The system of commodity money eventually evolved into a system of representative money.[citation needed]
This occurred because gold and silver merchants or banks would issue receipts to their depositors,
redeemable for the commodity money deposited. Eventually, these receipts became generally accepted as
a means of payment and were used as money. Paper money or banknotes were first used in China during
the Song dynasty. These banknotes, known as "jiaozi", evolved from promissory notes that had been used
since the 7th century. However, they did not displace commodity money and were used alongside coins. In
the 13th century, paper money became known in Europe through the accounts of travellers, such as Marco
Polo and William of Rubruck.[15] Marco Polo's account of paper money during the Yuan dynasty is the
subject of a chapter of his book, The Travels of Marco Polo, titled "How the Great Kaan Causeth the Bark
of Trees, Made Into Something Like Paper, to Pass for Money All Over his Country."[16] Banknotes were
first issued in Europe by Stockholms Banco in 1661 and were again also used alongside coins. The gold
standard, a monetary system where the medium of exchange are paper notes that are convertible into preset, fixed quantities of gold, replaced the use of gold coins as currency in the 17th–19th centuries in
Europe. These gold standard notes were made legal tender, and redemption into gold coins was
discouraged. By the beginning of the 20th century, almost all countries had adopted the gold standard,
backing their legal tender notes with fixed amounts of gold.
After World War II and the Bretton Woods Conference, most countries adopted fiat currencies that were
fixed to the U.S. dollar. The U.S. dollar was in turn fixed to gold. In 1971 the U.S. government suspended
the convertibility of the dollar to gold. After this many countries de-pegged their currencies from the U.S.
dollar, and most of the world's currencies became unbacked by anything except the governments' fiat of
legal tender and the ability to convert the money into goods via payment. According to proponents of
modern money theory, fiat money is also backed by taxes. By imposing taxes, states create demand for the
currency they issue.[17]
Functions
See also: Monetary economics
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In Money and the Mechanism of Exchange (1875), William Stanley Jevons famously analyzed money in
terms of four functions: a medium of exchange, a common measure of value (or unit of account), a
standard of value (or standard of deferred payment), and a store of value. By 1919, Jevons's four functions
of money were summarized in the couplet:
Money's a matter of functions four,
A Medium, a Measure, a Standard, a Store.[18]
This couplet would later become widely popular in macroeconomics textbooks. [19] Most modern textbooks
now list only three functions, that of medium of exchange, unit of account, and store of value, not
considering a standard of deferred payment as a distinguished function, but rather subsuming it in the
others.[4][20][21]
There have been many historical disputes regarding the combination of money's functions, some arguing
that they need more separation and that a single unit is insufficient to deal with them all. One of these
arguments is that the role of money as a medium of exchange conflicts with its role as a store of value: its
role as a store of value requires holding it without spending, whereas its role as a medium of exchange
requires it to circulate.[22] Others argue that storing of value is just deferral of the exchange, but does not
diminish the fact that money is a medium of exchange that can be transported both across space and time.
The term "financial capital" is a more general and inclusive term for all liquid instruments, whether or not
they are a uniformly recognized tender.
Medium of exchange
Main article: Medium of exchange
When money is used to intermediate the exchange of goods and services, it is performing a function as a
medium of exchange. It thereby avoids the inefficiencies of a barter system, such as the inability to
permanently ensure "coincidence of wants". For example, between two parties in a barter system, one
party may not have or make the item that the other wants, indicating the non-existence of the coincidence
of wants. Having a medium of exchange can alleviate this issue because the former can have the freedom
to spend time on other items, instead of being burdened to only serve the needs of the latter. Meanwhile,
the latter can use the medium of exchange to seek for a party that can provide them with the item they
want.
Measure of value
Main article: Unit of account
A unit of account (in economics)[23] is a standard numerical monetary unit of measurement of the market
value of goods, services, and other transactions. Also known as a "measure" or "standard" of relative worth
and deferred payment, a unit of account is a necessary prerequisite for the formulation of commercial
agreements that involve debt.
Money acts as a standard measure and a common denomination of trade. It is thus a basis for quoting and
bargaining of prices. It is necessary for developing efficient accounting systems like double-entry
bookkeeping.
Standard of deferred payment
Main article: Standard of deferred payment
While standard of deferred payment is distinguished by some texts,[22] particularly older ones, other texts
subsume this under other functions.[4][20][21][clarification needed] A "standard of deferred payment" is an accepted
way to settle a debt—a unit in which debts are denominated, and the status of money as legal tender, in
those jurisdictions which have this concept, states that it may function for the discharge of debts. When
debts are denominated in money, the real value of debts may change due to inflation and deflation, and for
sovereign and international debts via debasement and devaluation.
Store of value
Main article: Store of value
To act as a store of value, money must be able to be reliably saved, stored, and retrieved—and be
predictably usable as a medium of exchange when it is retrieved. The value of the money must also remain
stable over time. Some have argued that inflation, by reducing the value of money, diminishes the ability of
the money to function as a store of value.[4][failed verification]
Money Management: Definition and Top Money Managers by Assets
By
James Chen
Updated March 24, 2023
Reviewed by
Gordon Scott
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What Is Money Management?
Money management refers to the processes of budgeting, saving, investing, spending, or otherwise
overseeing the capital usage of an individual or group. The term can also refer more narrowly to investment
management and portfolio management.
The predominant use of the phrase in financial markets is that of an investment professional making
investment decisions for large pools of funds, such as mutual funds or pension plans.
Key Takeaways
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Money management broadly refers to the processes utilized to record and administer an
individual’s, household’s, or organization’s finances.
The term also refers more narrowly to investment and portfolio management.
Financial advisors and personal finance platforms such as mobile apps are increasingly common in
helping individuals manage their money better.
Poor money management can lead to cycles of debt and financial strain.
The biggest money managers by assets under management (AUM) are BlackRock, Vanguard, and
Fidelity.
Understanding Money Management
Money management is a broad term that involves and incorporates services and solutions across the entire
investment industry.
Consumers have access to a wide range of resources and applications that allow them to individually
manage nearly every aspect of their personal finances. As investors increase their net worth, they also
often seek the services of financial advisors for professional money management. Financial advisors are
typically associated with private banking and brokerage services, offering support for holistic money
management plans that can involve estate planning, retirement, and more.
In the growing financial technology market, personal finance apps exist to help consumers with nearly
every aspect of their finances.
Investment company money management is also a central aspect of the investment industry. Investment
company money management offers individual consumers investment fund options that encompass all
investable asset classes in the financial market.
Money Management
Written by CFI Team
Updated March 19, 2023
What is Money Management?
Money management refers to the process of tracking and planning an individual or group’s use of capital. In
personal and corporate finance, money management usually includes budgeting, spending, saving, and
investing.
Private banking financial advisors provide money management services to individual customers.
Commercial banking provides money management to corporate clients. In financial markets, money
management also refers to portfolio management and investment management. Financial professionals
manage investments and make investment decisions for pools of funds.
Summary
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Money management refers to the process of tracking and planning an individual or group’s
use of capital. In personal finance, money management includes budgeting, spending,
saving, and investing.
In corporate finance, money management covers the raising and use of capital. A firm’s
budgeting is mainly influenced by its business strategies.
In financial markets, money management refers to portfolio management and investment
management.
Money Management in Personal Finance
Money management is a broad concept. It refers to the strategies and techniques to determine the use of
an individual, company, or institution’s capital. In personal finance, money management covers budgeting,
spending, and saving (investing). Money management can be proactive with periodic or regular financial
planning. It can also be reactive to specific events without intuitive planning in advance.
As a result of different ages, lifestyles, family structures, and many other factors, financial plans for
individuals are different. However, the fundamental principles of budgeting can be commonly shared. For
example, one simple method of personal budgeting is the “50-20-30 Budget Rule.”
The 50-20-30 Budget Rule suggests an individual spends 50% of their after-tax income on essential
expenditures. The essentials include house mortgages or rents, transportation, groceries, utilities, and so
on. 30% of their income should be spent on the things that the person wants. It can include expenses on
partying with friends, movie tickets, and vacations. The remaining 20% should be saved or invested for
future financial goals.
Money management with intuitive planning and budgeting helps to reduce inessential expenditures. Such
expenditures do not add value to an individual’s living standards. They can be saved or invested for better
use in the future. Money management also lowers the risk of running out of money. It helps individuals to
achieve their financial goals in the long term.
Financial advisors in private banks, insurance firms, and other financial institutes provide personal money
management services. Individuals can also process their money management needs through personal
finance applications.
Understanding Money: Its Properties, Types, and Uses
By
THE INVESTOPEDIA TEAM
Updated July 04, 2022
Reviewed by CHARLES POTTERS
Fact checked by
YARILET PEREZ
Investopedia / Daniel Fishel
What Is Money?
Money is a system of value that facilitates the exchange of goods in an economy. Using money allows
buyers and sellers to pay less in transaction costs, compared to barter trading.
The first types of money were commodities. Their physical properties made them desirable as a medium
of exchange. In contemporary markets, money can include government-issued legal tender or fiat money,
money substitutes, fiduciary media, or electronic cryptocurrencies.
KEY TAKEAWAYS
Money is a system of value that facilitates the exchange of goods.
The use of money eliminates the problem of bartering where both parties must have something
the other wants or needs.
 Historically, the first forms of money were agricultural commodities, such as grain or livestock.
 Today, most money systems are based on standardized currencies that are controlled by central
banks.
 Digital cryptocurrencies also have some of the specific properties of money.
How Money Works
Money is a liquid asset used to facilitate transactions of value. It is used as a medium of
exchange between individuals and entities. It's also a store of value and a unit of account that can
measure the value of other goods.
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Prior to the invention of money, most economies relied on bartering, where individuals would trade the
goods they had directly for those that they needed. This raised the problem of the double coincidence of
wants: a transaction could only take place if both participants had something that the other needed.
Money eliminates this problem by acting as an intermediary good.
The first known forms of money were agricultural commodities, such as grain or cattle. These goods were
in high demand and traders knew that they would be able to use or trade these goods again in the future.
Cocoa beans, cowrie shells, and agricultural tools have also served as early forms of money.1
As economies became more complex, money was standardized into currencies. This reduced transaction
costs by making it easier to measure and compare value. Also, the representations of money became
increasingly abstract, from precious metals and stamped coins to paper notes, and, in the modern era,
electronic records.
During World War II, cigarettes became a de facto currency for soldiers in prisoner-of-war camps. The use
of cigarettes as money made tobacco highly desirable, even among soldiers who did not smoke.2
What Are the Properties of Money?
In order to be most useful, money should be fungible, durable, portable, recognizable, and stable. These
properties reduce the transaction cost of using money by making it easy to exchange.
Money Should Be Fungible
The word fungible refers to a quality that allows one thing to be exchanged, substituted, or returned for
another thing, under the assumption of equivalent value. Thus, units of money should be interchangeable
with one another.
For example, metal coins should have a standard weight and purity. Commodity money should be
relatively uniform in quality. Trying to use a non-fungible good as money results in transaction costs that
involve individually evaluating each unit of the good before an exchange can take place.
Money Should Be Durable
Money should be durable enough to retain its usefulness for many, future exchanges. A perishable good
or a good that degrades quickly due to various exchanges will be less useful for future transactions. Trying
to use a non-durable good as money conflicts with money's essential future-oriented use and value.
Money Should Be Portable
Money should be easy to carry and divide so that a worthwhile quantity can be carried on one's person or
transported. For example, trying to use a good that's difficult or inconvenient to carry as money could
require physical transportation that results in transaction costs.
Money Should Be Recognizable
The authenticity and quantity of the good should be readily apparent to users so that they can easily agree
to the terms of an exchange. Using a non-recognizable good as money can result in transaction costs
relating to authenticating the goods and agreeing on the quantity needed for an exchange.
Money's Supply Should Be Stable
The supply of the item used as money should be relatively constant over time to prevent fluctuations in
value. Using a non-stable good as money produces transaction costs due to the risk that its value might
rise or fall, because of scarcity or over-abundance, before the next transaction.
How Is Money Used?
Money primarily functions as the good people use for exchanges of items of value. However, it also has
secondary functions that derive from its use as a medium of exchange.
Money as a Unit of Account
Due to money's use as a medium of exchange for buying and selling and as a value indicator for all kinds
of goods and services, money can be used as a unit of account.
That means money can keep track of changes in the value of items over time and multiple transactions.
People can use it to compare the values of various combinations or quantities of different goods and
services.
Money as a unit of account makes it possible to account for profits and losses, balance a budget, and
value the total assets of a company.
Money as a Store of Value
Money's usefulness as a medium of exchange in transactions is inherently future-oriented. As such, it
provides a means to store a monetary value for use in the future without having that value deteriorate.
So, when people exchange items for money, that money retains a particular value that can be used in
other transactions. This ability to function as a store of value facilitates saving for the future and engaging
in transactions over long distances.
Money as a Standard of Deferred Payment
To the extent that money is accepted as a medium of exchange and serves as a useful store of value, it
can be used to transfer value over different time periods in the form of credits and debts.
One person can borrow a quantity of money from someone else for an agreed-upon period of time, and
repay a different agreed-upon quantity of money at a future date.
What Are the Different Types of Money
Market-Determined Money
Money can originate out of the spontaneous order of markets. As traders barter for various goods, some
goods will prove more convenient than others because they have the best combination of the five
properties of money listed above.
Over time, these goods may become desirable as objects of exchange, rather than for practical use.
Eventually, people may come to desire a good solely for future trading.
Historically, precious metals such as gold and silver were often used as market-determined monies. They
were highly prized across many different cultures and societies. Today, people in cashless economies
frequently turn to cigarettes, instant noodles, or other nonperishable goods as a market-determined
money substitute.2
Government-Issued Currency
When a certain type of money is widely accepted throughout an economy, government bodies may begin
regulating it as a currency. They may issue standardized coins or notes to further reduce transaction
costs.
A government may also recognize some money as a legal tender, meaning that courts and government
bodies must accept that form of money as a final means of payment.
Issuing money allows the government to benefit from seigniorage, the difference between the face value
of a currency and the cost to produce it.
For example, if the cost of printing a $100 bill is only $10, the government will earn a $90 profit for each
bill it prints. However, governments that rely too heavily on seigniorage may inadvertently debase their
currency.
$20.6 Trillion
The total value of the M1 money supply in the United States as of May 2022.3
Fiat Currency
Many countries issue fiat currency, which is currency that does not represent any type of commodity.
Instead, fiat money is backed by the economic strength of the issuing government. It derives its value from
supply and demand and the stability of the government.
Fiat money allows the issuing government to conduct economic policy by increasing or reducing the
money supply. In the U.S., the Federal Reserve and the Treasury Department monitor several types of
money supplies for the purpose of regulating and mitigating monetary issues.4
Since fiat money does not represent a real commodity, it falls to the issuing government to ensure that it
meets the five properties of money outlined above.
The International Monetary Fund (IMF) and World Bank serve as global watchdogs for the exchange of
international currencies.56 Governments may enact capital controls or establish pegs in order to stabilize
their currency on the international market.
Money Substitutes and Fiduciary Media
To reduce the burden of carrying large quantities of currency, merchants and traders sometimes
exchange money substitutes such as written statements of debt that can be redeemed later. These
statements can themselves adopt some of the properties of money, particularly if traders use them in lieu
of actual currency.
For example, ancient banks issued bills of exchange to their depositors, stating the amount that had been
deposited and the terms for redemption. Rather than withdraw money from the bank to make payments,
depositors would simply trade their bills, allowing the recipient to redeem or trade them at will.7
This use of money substitutes can increase the portability and durability of money, as well as reduce the
cost of storage. However, there are risks involved with money substitutes. Banks may print more bills than
they have money to redeem, a practice known as fractional reserve banking. If too many people try to
make withdrawals at the same time, the bank may suffer from a bank run.
Fiduciary media are types of money substitutes introduced into circulation that aren't fully backed by the
base money held to back money substitutes.8 For example, paper checks, token coins, and electronic
credit represent contemporary examples of fiduciary media.
Cryptocurrencies As Money
In recent years, digital currencies that do not exist in physical form, such as Bitcoin, have been introduced.
Unlike electronic bank records or payment systems, these virtual currencies are not issued by a
government or other central body. Cryptocurrencies have some of the properties of money and are
sometimes used in online transactions.
Although cryptocurrencies are rarely used in everyday transactions, they have achieved some utility as a
speculative investment or a store of value. Some jurisdictions have recognized cryptocurrencies as a
payment medium, including the government of El Salvador.
What Are the 4 Types of Money?
Money can be something determined by market participants to have value and be exchangeable. Money
can be currency (bills and coins) issued by a government. A third type of money is fiat currency, which is
fully backed by the economic power and good faith of the issuing government. The fourth type of money is
money substitutes, which are anything that can be exchanged for money at any time. For example, a
check written on a checking account at a bank is a money substitute.
What Is the Difference Between Hard and Soft Money?
Hard money is money that is based on a valuable commodity, such as gold or silver. Since the supply of
these metals is limited, these currencies are less susceptible to inflation than soft money such as printed
banknotes. With no guarantee that extra notes will not be printed, soft money may be considered risky by
some.
Is Cryptocurrency Money?
Cryptocurrency has many of the properties of money and is sometimes used as a medium of exchange for
transactions. Many governments consider cryptocurrency to be a taxable asset, but very few give it the
same legal treatment as a foreign currency. Some jurisdictions, notably El Salvador, have embraced
cryptocurrency.
The Bottom Line
Money is some item of value that allows people and institutions to engage in transactions that result in an
exchange of goods or services.
Money has to be exchangeable, convenient to carry, recognized as legitimate by all, physically longlasting, and have a value that's stable.
Money comes in various forms, including precious metals, currencies, and money substitutes. At this time,
though cryptocurrencies have some of the properties of money, they function without a central authority
and aren't backed by governments. While cryptocurrencies (such as Bitcoin) are considered property for
tax purposes by the IRS, they aren't considered legal tender by the U.S. government.9