If you are reading this, you have probably understood how important is to have a clear picture about your financial position, before starting stock trading. In this part we will show you how to prepare your personal balance sheet. Stock trading will normally increase your financial position’s volatility so you will have to keep track of your financial situation more frequently.
The first part of your personal financial statements is the balance sheet, the “snapshot” of what you own and what you owe. A typical balance sheet is comprised of three elements. The assets you have in your possession (Assets), the part of assets that you own (Equity) and the part of assets that you owe (Liabilities, Debt). Your car is an asset that you may have bought using your savings (Equity) and a car loan (Debt). If you do not owe anything (credit card debt, personal debt, mortgage) to anyone (bank, IRS), then your balance sheet is comprised of assets and equity (your net worth). When preparing your balance sheet be cautious not to overestimate your net worth and underestimate debt. This exercise is neither to impress your neighbor nor to secure financing from the local bank. You personal balance sheet should look like this:
| Liquid Assets | Liabilities (Debt) | ||||
| Cash in Hand | 1,000 | Credit Card(s) | 1,500 | ||
| Bank Savings | 10,000 | Personal Loan(s) | 2,500 | ||
| Bonds | 20,000 | Car Loan(s) | 10,000 | ||
| Stocks | 5,000 | Mortgage | 70,000 | ||
| Mutual Funds / ETFs | 5,000 | Total Liabilities | 84,000 | ||
| Illiquid Assets | |||||
| Car(s) | 15,000 | ||||
| Residence | 150,000 | ||||
| Investments | 100,000 | Equity (Net Worth) | 222,000 | ||
| Total Assets | 306,000 | Total Liabilities + Equity | 306,000 | ||
Note that it is fairly straightforward to calculate most of the balance sheet items such as liquid assets and debt. For the other items (car(s), residence, other investments) you might have to use an “estimate”, a value that is representative of what something is worth. Sometimes it is very hard to get these estimates, if market prices are not available for similar assets. Always try to reach an estimate by searching for market prices or by seeking professional advice. However, for this exercise it suffices to find market prices for assets with the same characteristics as your assets.
The most important objective related to your personal balance sheet is to own more than you owe. Normally, positive net worth is a necessary and sufficient condition to gradually achieve your financial goals. You should focus on increasing your assets and decreasing your debt. There are many ways to achieve this. A simple and effective way to improve your financial condition is to organize and monitor your income and expenses using your personal cash flow statement.
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