Steps to Building a Complete Financial Portfolio

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Image by Gary Ferster © The Balance 2019

You have a dream about your life. You know where you want to live, what you want to drive, and the type of clothes you want to wear. Have you ever stopped to calculate exactly what it would cost you, in financial terms, to achieve that desired lifestyle? If you're like most people, the answer is no.

This step-by-step guide empowers you to take action by building a complete financial portfolio. This means that not only do you own diversified investments across different asset classes, but you also have fully-funded retirement accounts, own your home, are debt-free, have a six-month emergency cash reserve, and you invest in yourself. Ensuring that each of these areas is optimized will set you up for financial success.

Before you Begin Building your Complete Financial Portfolio

Make a list of everything you own. Include assets such as cars, stocks, bonds, mutual funds, cash, and bank accounts. Next, list everything you owe, such as student loan debt and credit card balances.

Be brutally honest—don't keep something off the list because you'll "get to it tomorrow" or "it isn't a problem." The key to changing your life is to determine exactly where you stand right now. Be brave enough to look at the full picture.

This balance sheet is going to be extremely important as you craft your way through the following steps. It's a picture in time, the first step in understanding your net worth. Your balance sheet is a benchmark you measure against as you build your financial future.

Commit to Change

The process of building a complete financial portfolio can take years. But don't despair. If you are dedicated and diligent, you will reach your goal, so don't lose hope. Commit to improving your finances and remind yourself of this commitment frequently.

Contribute to Your 401k With Your Employer's Matching Funds

Many businesses match the contributions their employees make to their 401(k) accounts. The amount of these matching contributions can vary widely from company to company; most providing an escalation in benefits based upon tenure.

Yet, despite this free cash, some people do not take advantage, either because they don’t understand the time value of money or don’t believe they can afford to have their take-home pay reduced.

The fact is you can’t afford not to contribute. If your employer matched you dollar-for-dollar—for instance, up to the first 5% of your contribution—you would immediately be earning a 100% ​return on your investment. What other investment can guarantee returns like that?

When you consider these funds will also grow tax-deferred in your 401(k) for the next 20, 30, or 40 years, the opportunity cost over the length of a career can be millions of dollars.

The bottom line: Even if you are buried under a mountain of credit card debt, can’t pay your monthly bills, and have your telephone disconnected, you must contribute to your 401k up to the amount of your employer’s match.

If No Match Is Offered

If your employer doesn’t match your contributions, you won't benefit by putting this step first. Instead, don’t contribute to your 401(k) until you’ve completed the next several steps.

Pay Off High-Interest Credit Card Debt

The next step in building your complete financial portfolio is to develop a plan for paying down high-interest credit card debt.

  • Rank your debts by interest rate: Take the balance sheet you prepared and, on a separate sheet of paper, rank all of your debts by the interest rate you are paying starting with the highest.
  • Allocate as much as possible to debt pay-down: Decide how much you can afford to dedicate to debt reduction each month from your regular income. If you are making regular contributions to a mutual fund or investment account outside of your 401(k) match, temporarily stop and add that money to your “debt-reduction” funds.
  • Attack the card with the highest interest: Pay the minimum balance on all of the debts except the highest-ranked on the list (the card with the highest interest rate). The highest-ranked card should receive all of the capital (less the minimums on the other debts) you can afford to part with until it has been completely paid off.
  • Eliminate debts one by one: When you’ve wiped out a balance, cross the card off your list and put it in a drawer. Do not cancel the card; this will lower your credit score and cause the interest rate you pay on ​the variable rate and new debt to increase. Do not charge to it again.
  • Keep going: Continue this process until all of these accounts are paid in full.

The process may take months or even years. The key is to avoid making new charges and work to find extra money to pay down debt faster. This doesn’t mean you have to abandon your cards altogether; they are not inherently evil. In fact, credit cards can be a valuable financial tool if used responsibly.

Open and Fully Fund a Roth IRA

The Roth IRA is one of the best financial accounts available to investors in the U.S. The odds are good you qualify; as long as your annual income does not exceed $139,000 (single) or $206,000 (married), you can open a Roth IRA.

Contributions—subject to annual limits—are made with after-tax dollars. All Roth IRA contributions can be withdrawn at any time without any penalty.

Once you reach the age of 59 1/2, as long as your account has been open for five years, all withdrawals are tax-free.

In other words, if you purchased $10,000 worth of a stock through your qualified Roth IRA and held it for 20 years, and that company turned out to be the next Microsoft, you could sell your stake at retirement and you would owe Uncle Sam nothing—even if that stock grew to be worth millions of dollars.

Additional Benefits of a Roth IRA

  • No mandatory distribution age
  • Roth IRA contributions can be used to purchase a variety of investments (stocks, bonds, certificates of deposit (CDs), etc.)
  • If you’ve received unemployment compensation at least 12 weeks, you can use Roth IRA funds to pay medical insurance premiums without penalty
  • Certain higher education costs for you, your spouse, and your immediate family can be funded through your Roth IRA
  • Medical expenses in excess of 7.5% of your gross adjusted income can be paid for, without penalty, by your Roth IRA.

You can open a Roth IRA at any bank or brokerage firm.

Purchase a Home

The next step in constructing a complete financial portfolio is to save for a down payment on a house. By owning your own home, you are converting what was previously an expense (rent) into equity.

To sweeten the deal, not only is the interest paid on your mortgage tax-deductible, but you are permitted a lifetime capital gains tax exemption of $250,000 (single) or $500,000 (married) if you sell your home at a profit.

From an investment standpoint, this is particularly attractive.

Say you put 20% down on a $100,000 house. (That's a typical down payment amount if you want to avoid private mortgage insurance.) If that home appreciates 4%, or $4,000, in a year, you've just seen a 20% return on your investment of $20,000 cash. 

Looking at it that way, buying a home is a practical investment that can generate a decent return and diversify your holdings into real estate at the same time.

Additional Costs of Becoming a Homeowner

You should note, however, that the costs of becoming a homeowner are significantly more than just a mortgage payment. Costs that you need to consider include:

  • Private mortgage insurance (for down payments less than 20% of the property value)
  • Homeowner insurance
  • Utility bills
  • Home repairs (broken furnace, appliances, etc.)
  • Lawn care (if you’re living outside of a major city)
  • Property tax

Build a Six-Month Emergency Reserve

Once you are a homeowner, you must establish a six-month emergency cash reserve to cover basic living expenses. This will allow you to weather any unexpected storms, including surprise home repairs, sudden unemployment, and medical bills. At a minimum, your emergency fund should be sufficient to cover up to six months of the following:

  • Mortgage payments
  • Insurance costs
  • Utility bills
  • Groceries
  • Fixed payments (car payments, student loan payments, and the like)
  • Minimum payments on credit cards

Keep Your Emergency Fund Liquid

The primary investment objective for your emergency cash reserve is safety, not return. The simplest option is to park the funds into savings or a money market account. If you are interested in generating extra income, consider building a laddered certificate of deposit (CD) portfolio.

Building a Laddered Emergency Cash Reserve

Assume your emergency cash reserve is $12,000. To build a laddered CD portfolio, you would go to your local bank and open six CDs as follows:

  1. $2,000 30-day (1 month) maturity
  2. $2,000 60-day (2 month) maturity
  3. $2,000 90-day (3 month) maturity
  4. $2,000 120-day (4 month) maturity
  5. $2,000 150-day (5 month) maturity
  6. $2,000 180-day (6 month) maturity

As each CD matures, roll it over into a new six-month CD. In short order, you will own six separate six-month CDs, one of which will mature every month. Laddering your investments this way allows you to compound your interest with each new CD.

Pursue Other Investment Opportunities

If you have followed the step-by-step for building a complete financial portfolio so far, you have contributed to your 401(k), paid off your credit card debt, fully funded a Roth IRA, purchased a home, and established a six-month emergency fund. Now, it’s time to turn your eyes to additional investment opportunities by opening a brokerage account.

The Range of Investments Available

A brokerage account will allow you to invest in stocks, bonds, mutual funds, certificates of deposit, real estate investment trusts (REITs), Treasurys, and other investments.

Selecting a broker is largely a question of what you want: are you looking for a relationship with a single person whom you can call? Go for a traditional broker. Or are you fine with placing most of your trades online or with a broker you do not know? In that case, go with a discount broker.

The primary benefit of the latter model is significantly lower trading costs. Many brokerage firms offer both models and allow the client to choose at the time they open their account.

Invest in Yourself

If you’re thinking about starting a business, improving your professional skills, or standing out to potential employers, consider investing in yourself by taking educational courses. They will help you increase your earning potential, enabling you to accelerate your financial plan.

Many colleges and universities offer professional certification programs. For example, New York University's School of Professional Studies certificates available include Finance, Entrepreneurship, Management, and Technology, among others. Some courses and certification programs are available online.

A great option for many investors is to enroll in basic accounting and finance courses. Although the cost may be several thousand dollars, the knowledge you gain can make a significant difference in your income if applied wisely, paying for itself many times over.

Save for Your Childrens' Education

Here's a secret: You have no obligation to put your child through school. Of course most parents want the best life for their children, but consider that an education may be more valuable to the recipient if he has "skin in the game," and is required to fund or at least help with the costs, which can be exorbitant.

Retirement First

Regardless of your opinion on the matter, it is vital that you save for your retirement before you put funds aside for your child’s education. If you are short on cash when it is time for the kids to go to college, there are numerous low-interest loan options available in addition to scholarships, grants, and federal student aid. However, if you arrive at retirement with empty pockets, there is no federal "retirement aid" or loan to help you.

Stay the Course

Congratulations! The hard work is done—you’ve laid the foundation for a solid financial future. The key to success is making intelligent decisions and sticking to the basics of building a complete financial portfolio.

There is nothing magical about wealth building; it is achieved through a culmination of small, disciplined choices. Keep your mind on the larger goal as you navigate everyday decisions and you will find yourself making good progress.