Create a Personal Balance Sheet and Cash Flow Statement
To know how to get to where you want to go, you must review today’s hard numbers. Create a personal balance sheet — much like that of a business — where you record all your assets and liabilities and net them out to determine your net worth. List all of your cash and cash-like assets (ex. bonds that mature within a year), your invested assets (ex. 401ks, IRAs, taxable investment accounts), and your personal use assets (ex. your primary home, vacation home, art collection). Next, list all current (mature within a year) and long-term liabilities (ex. home mortgage). Net your assets and liabilities to determine your net worth.
Follow a similar system for your cash flow statement. Here, you will net all of your inflows (earned and rental income, social security, etc.) against your outflows (living expenses, taxes, etc.). If netting your inflows and outflows leaves a positive number, you have a surplus; a negative number means a deficit. With both your balance sheet and cash flows in hand, you can plan to achieve your financial goals.
Understand Your Comfort with and Exposure to Risk
Every investment portfolio involves some risk. Building your plan requires you to know how much risk you can accept. Conservative investors generally have very little tolerance for portfolio volatility. Preserving capital is their top priority. Aggressive investors are generally indifferent to large fluctuations in their portfolio value. They prioritize growth over safety of principal. Are you in one of these two categories, or somewhere in between?
With your comfort level in mind, it is essential to review your current risk exposure. Are you a conservative investor who owns high-risk investments? Perhaps you are an aggressive investor allocated too conservatively. You should ensure that your risk tolerance is reflected in your asset allocation.