In my first blog I mentioned that I’d explain more about the portfolio-building process. Thinking of building made me realize just how much constructing an investment portfolio and, well … constructing, a building have in common.

You need to have a clear blueprint of your design; select the most appropriate materials; fit the pieces together in a solid, balanced way; and keep checking to ensure it’s structurally sound. That’s the process I’d look for when choosing a builder for the home I’d live in with my family—and the one I follow when building portfolios for my clients. (In this case, it means determining your investing goals, selecting the appropriate diversified mix of investments and putting them in the appropriate types of accounts, and rebalancing regularly.)

It’s a lot to take in at once, so we’re going to explore each step in the process through the perspective of a “model” client family.

Meet Jim and Sue Smith

Let me introduce you to Jim and Sue. We’ll visit them throughout the portfolio-building process.

  • Married, both in in their 50s.
  • Both to receive Social Security; Jim also has a pension from an employer.
  • Investment accounts with several firms, including employer retirement plans, individual IRAs, Roth IRAs, and non-retirement accounts.
  • Unsure of their overall asset allocation or of all the different investments they hold.

Decide on the structure by setting goals

Because goals—particularly for retirement—are the base for your investment plan, I start by asking clients like Jim and Sue a foundational question: “When do you want to retire and what do you want to do?” The Smiths let me know that they’d like to retire when they reach age 65, in about 10 years.

But I want them to get a clear picture. I’ll also ask them very specific questions: Will they be downsizing? How do they envision their daily life? Travelling? Playing golf? Volunteering? I want Jim and Sue to verbalize to me what is important to them.

This is a crucial exercise for two reasons. First, it helps the Smiths get excited about their future, which will allow them to stay focused on what they need to do to achieve their dream. They’ll be able to see the bones of their blueprint take shape.

Second, they can get a handle on the construction costs, including the risk premium they’re comfortable paying, for their long-term goals.

Determine short- and long-term budget

Analyzing the Smiths’ cash flow in depth helps determine where they’re on the right track and where they have, let’s say, opportunity areas. Here are the things I need to know for the analysis:

  • What will their income needs be in retirement? In the Smiths’ case, their retirement is 10 years away and they’re not too sure exactly what they’ll need, so we’ll use 85% of their current income as a guide.
  • How much income can they count on receiving? I’ll take into account their future income, such as Social Security and Jim’s pension.
  • How much are they currently saving in their accounts?
  • How much do they already have in their various accounts? (I can preload their Vanguard balances.)

You can use our retirement income calculator to do this yourself.