Steps to Building a Complete Financial Portfolio

1
Take Stock of Your Life

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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. What is a complete financial portfolio? It is a term I use to define an individual who has fully-funded retirement accounts, is debt-free, has a six-month emergency cash reserve, owns diversified investments across different asset classes, and invests in themselves.

Before you Begin Building your Complete Financial Portfolio

Sit down, take out a pen, and make a list of everything you own (e.g., assets such as cars, stocks, bonds, mutual funds, cash, bank accounts) and everything you owe (e.g., liabilities such as student loans, 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 in this moment in time. This balance sheet is going to be extremely important as we craft our way through the following steps. It's a picture in time, the first step in understanding your net worth, it's a benchmark as you build your financial future.

Commit to Change

The process of building a complete financial portfolio can take years. If you are dedicated and diligent, you will reach your goal, so don't lose hope!

2
Contribute to Your 401k with Your Employer's Matching Funds

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In 401k Retirement Plan: Begin Building for Your Future, you learned that many businesses match contributions employees make to their 401k 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 individuals 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 matches $1-for-$1 up to the first 5% of your contribution, you are immediately earning a 100% return on your investment. There is no investment in the world that can guarantee returns even close to that amount. When you consider these funds will also grow tax-deferred in your 401k for the next twenty, thirty, or forty years, the opportunity cost over 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 your employer doesn’t match, don’t contribute anything until you’ve completed the next several steps.

3
Pay Off High-Interest Credit Card Debt

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

  • 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; highest first.
  • 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 401k match, temporarily stop and add that money to your “debt-reduction” funds.
  • Pay the minimum balance on all of the debts except the highest-ranked on the list (i.e., 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.
  • 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.
  • 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 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.

4
Open and Fully Fund a Roth IRA

Invest money into your ROTH
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The Roth IRA is, in my opinion, the greatest financial account available to investors in the United States. The odds are good you qualify; as long as your annual income does not exceed $95,000 (single) or $150,000 (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 (subject to the five-year rule), all withdrawals are absolutely, 100% tax-free. In other words, if you purchased $10,000 worth of the next-Microsoft through your Roth IRA and held it for twenty years, selling the stake at retirement for $5 million, you would owe Uncle Sam nothing.

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 deposits, etc.)
  • If you’ve been unemployed for longer than twelve 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. Read the following articles a list of IRA contribution limits and additional benefits.

5
Purchase a Home

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The next step to 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. As financial guru Suze Orman frequently reminds her fans, most homes appreciate at 3-4% per year and are purchased with 20% down. A $100,000 house, for example, would appreciate $3,000 to $4,000 per year, or nearly 20% on the $20,000 cash investment (the down payment.) There is no other investment in the world that is practical, generates a comparable return and diversifies one’s asset allocation into real estate at the same time.

Additional Costs of Becoming a Homeowner

The costs of becoming a homeowner are significantly more than the basic 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

6
Build a Six-Month Emergency Reserve

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Now that you are a homeowner, it is more important than ever that you establish a six-month emergency cash reserve to cover basic living expenses. This will allow you to weather any unexpected storms including home repairs, unemployment, and medical bills. At the very least, the emergency cash reserve 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, etc.)
  • Minimum payment on credit cards

Investing Your Emergency Cash Reserve

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 portfolio.

Building a Laddered Emergency Cash Reserve

Assume your emergency cash reserve is $12,000. You would go to your local bank and open six certificates of deposits (CD's) 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 certificate of deposit matures, roll it over into a new six-month CD. In short order, you will own six separate six-month CD's, one of which will mature every month.  

7
Pursue Other Investment Opportunities

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Great work! If you’ve followed the step-by-step for building a complete financial portfolio, you have contributed to your 401k, 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.

Range of Investments Available

A brokerage account will allow you to invest in stocks, bonds, mutual funds, certificates of deposit, real estate (via REITs), treasuries, and more. 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 (i.e., a traditional broker), or do you want to place most of your trades online or with a broker you do not know (i.e., 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. For help making the right decision, take a look at the article Before You Open a Brokerage Account.

8
Invest in Yourself

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Increase Your Education

If you’re thinking about starting a business, improving your professional skills, or making yourself stand out with your employer, you may want to consider investing in yourself by taking educational courses. Many colleges and universities offer professional certification programs such as NYU’s School of Continuing and Professional Studies; certificates available include Financial Analysis, Accounting, Bookkeeping, Portfolio Management, French, German, Italian, International Affairs, Web Development, Marketing, Property Management, Real Estate Finance and Investment, Cinematography, Product Design and more. Some courses and certification programs are available online.

As the investing for beginners guide, I'm often asked advice for someone starting out on their own. The answer is almost invariably: 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, many times over.

9
Save for Your Childrens' Education

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Many financial advisors have finally let the dirty secret out of the bag: you have no obligation to put your child through school. Most parents obviously want the best life for their posterity but there are convincing arguments that you will do much greater good by requiring them to fund their own education. Perhaps the best solution is to wait until after graduation – evaluate the academic performance, the professional drive, and the qualitative characters objectively. If you like what you see, offer to pay for all or a portion of the education. That way, if little John takes seven years to graduate because he’s spending all of his free time at frat parties, he can bear the consequences while you enjoy your new Mercedes.

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, highly-favorable loan options available in addition to scholarships, grants, and Federal aid; if you arrive with empty pockets at retirement, however, there is no one there to help fund your lifestyle.

Investing Education Assets for Financial Aid

Financial aid calculations are more favorable when assets are held in the parents’ name, rather than the child's.

10
Stay the Course

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Congratulations! The hard work is done – you’ve laid the foundation. The key to success is making intelligent decisions and sticking to the basics of the complete financial portfolio. There is nothing magical about wealth building; it is achieved through a culmination of small, disciplined, choices. To borrow a line from the important book The Richest Man in Babylon, you must keep your mind on the bigger goal to “protect your true wants from your casual desires.”