Preparing to Invest
So you heard about the stock market and the potential riches it can give you?. Great. Now hold on. Before you go out and open an account with a broker and put your saving or the money you've got and start trading you need to first make an analysis of your financial situation.
This is a crucial step. If your financial situation isn't sound, you have no place in the stock market or in the investing world.
In order to analyze your financial situation, be sure to follow these steps:
1. Establish a starting point
You need to find out how much money you can afford to invest in stocks. The first rule of investing is: Never invest money you cannot afford to lose. That means that if you got $4000 in a bank account, and only have that one bank account and your job, and want to invest that $4000 in the market, forget it.
Now, that you have your starting point – wanting to analyze your financial situation, turn to step 2
2. Prepare a balance sheet
A balance sheet is a list of your assets, your liabilities and what each item is currently worth, so you can arrive at your net worth. Net worth = total assets – total liabilities.
Here is how a balance sheet looks like for a small business:
Don't worry, your balance sheet wont' be that complex (although this one is a fairly short one).
Now let's start in preparing your balance sheet.
Pull out a pen/pencil and paper. (I have included an excel spreadsheet at the end of the post for those of you who love excel).
The second document you should prepare is your income statement. An income statement lists your total income and your total expenses, that way you can see how well you are doing.
If total income > total expenses, great !
If total income <>
Make sure you have an emergency fund !
Your main goal here is to have a reserve fund comprised of 3 to 6 months of your living expenses in cash. Why ? Because you might lose your job, and finding a new job could take anywhere from 3-6 months, and this way you will be safe in case the unfortunate event happens. Too many people don't have an emergency fund, and thus they put themselves at risk.
Be sure that before you think about putting money into the market you have an emergency fund.
Now let's move on
- List your assets in decreasing order of liquidity
Liquidity refers to how quickly you can convert an asset into cash. Listing your assets in order of liquidity on your balance sheet gives you an immediate picture of which assets you can quickly convert to cash and which ones you can't.
Here is an example of a list of assets in order of liquidity. Use it as a guide for making your own asset list
| Asset Item | Market Value | Annul Growth Rate% |
| Cash on hand and in checking | $200 | 0 |
| Bank savings accounts and certificates of deposit | $1,000 | 2% |
| Stocks | $5,000 | 10% |
| Mutual Funds | $2,000 | 9% |
| Collectibles, art etc | $250 | |
| Auto | $5,000 | -10% |
| Residence | $150,0000 | 5% |
| Total Assets | $163,450 | |
- List your liabilities
Liabilities are bills that you're obliged to pay. It is important to also keep track of your liabilities, because otherwise you may end up thinking that you have more money than you really do.
Look at the table below as an example and use it as a template for your list
| Liabilities | Amount | Paying Rate |
| Credit Cards | $4,000 | 15% |
| Personal loans | $15,000 | 10% |
| Mortage | $100,000 | 8% |
| Total liabilities | $117,000 | |
- Calculate your net worth
Net worth indicates your total wealth. You can calculate it with this basic equation: total assets – total liabilities = net worth
In our example, our net worth would be: $163,450 – $117,000= $46,450
- Now analyze
You have created your balance sheet. Now analyze it and identify ways in which you can increase your wealth. For example taking the money from the cash account and paying off the debt on the credit card because it charges you a lot of interest, etc
Taking hold of your personal finances is a very important part of your journey to becoming financially independent.
I recommend using Quicken as your tool for personal finance. I use it and am very happy with it.
