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What Am I Investing For?
Define your investing goals before determining whether capital gains or cash flow investments are right for you.
Before you turn over your down payment on an investment property or write a check for $2,000 in stocks, it's a good idea to know what exactly you're investing for. It surprises me how many people, many of whom have already purchased investments, don't understand this one basic concept of investing. If you learn this single fundamental, you'll be ahead of the game.
Two Things Count
With any investment, there are generally two things you invest for: capital gains or cash flow.
Capital gains is the profit you make on the sale of an investment. For example, you buy a house for $100,000. You put a little money into fixing up the property. You then sell the property for $150,000. Your profit on that sale is called capital gains. The same applies to stocks. You purchase shares of a stock at $25 per share. The stock price goes to $35 per share. Your profit when you sell is your capital gains. A capital gain is only realized when you actually sell the investment. Of course, if you sell the investment and lose money, you have a capital loss.
Cash flow is money that comes in on a regular basis from an investment you hold on to. Let's go back to that $100,000 house. Instead of fixing it up and selling it, you fix it up and rent it out for $1,000 per month. Each month you collect your rent and pay the expenses, such as repairs, taxes and insurance, and the mortgage. If you've managed the property well, at the end of each month you'll have a profit--or positive cash flow--that goes into your pocket. Some stocks deliver cash flow in the form of dividends. Or maybe you've invested in a friend's startup and she agrees to pay you 12 percent per year on the money you invested with her. That's also cash flow.
A simple way to remember the two concepts and the difference between them is a gain is a one-time event or sale; cash flow is continual, or flowing.
Which Strategy Is Best?
Why is knowing the difference important? It depends on what your investment goals and interests are. One strategy isn't better than the other, just different.
In 1989 when I bought my first rental property, my husband, Robert, and I had a goal: to be financially free. Our definition of financial freedom was having more money coming in every month from our investments than was going out each month for living expenses. Not rocket science. Yet by defining that goal, our focus went immediately to cash flow.
To have money flow in every month, our plan was to buy, hold and rent our properties. We accomplished our goal of financial freedom in 1994. We had $10,000 coming in each month from our apartment buildings and a few single-family homes. The beauty of this formula was that our living expenses were only $3,000 per month. At that point, we were free. We no longer had to work for money because our money was working for us. That, to me, is the beauty of cash flow: It's not about the amount of money you accumulate, it's about the freedom it brings you.
That certainly doesn't mean that investing for capital gains doesn't have merit. It's just not my primary strategy. Ideally, I look for investments that have cash flow and future capital gains, also known as appreciation. I want every investment I make to appreciate over time. The difference is I don't invest with just one strategy, hoping and praying that the property appreciates quickly so I can sell it and make a profit.
"The Rich Woman in You" is about attaining financial independence. Only you can decide how best to do that. If stock trading is your thing, then go for it full-tilt. If you enjoy buying and selling properties, then have at it. Just be clear on what your financial goal is.
A Difference to Consider
The main difference for me between the two strategies is this: If I only focus on buying and selling investments, which is the capital gains approach to investing, then I have to keep doing it again and again to amass millions of dollars to cover my living expenses if my goal is to be financially free and independent. I don't have money coming in each month on a steady basis. Once I sell an investment, I need to buy and sell another to amass more money. To me, it's a much longer and more time-consuming process.
A Money Rule for Life
And that thought brings up an important rule that I live by. Any dollar that goes into my investment or asset column stays in that column. In other words, let's say I put $100,000 as a down payment on a $1 million property. Each month that property gives me a cash flow of $1,000, or 10 percent. I can use that cash flow from my property any way I want, but if I sell that property, the original $100,000 goes into another investment. I don't spend it because I want my investment portfolio to keep growing.
Similarly, if I buy 100 ounces of silver--and I do buy a good amount of 1-ounce silver coins or larger bars--it would cost me about $1,500 today. Then, if I sell that silver at a later date, I'll move the original $1,500 into a new investment. My profit or capital gain is mine to do with as I choose.
What I see happening repeatedly is that a person buys the $1,500 worth of silver and when an unexpected expense pops up, such as needing to buy new tires for her car, she cashes in her silver and buys the new tires. Now she's back at square one without any investments.
Once you've committed a dollar for an investment, that dollar should never go toward anything other than investments. If that investment is the first place you turn to when a financial emergency arises, your investment portfolio will never grow, and you'll find yourself back at square one time and time again.
Is It One or the Other?
Do I ever invest for capital gains? Absolutely. It's not my primary focus, but I do have capital gains investments. Next month, I'll tell you how I used both capital gains and cash flow in one real estate deal to accomplish my goal. I'll also discuss some other properties I've purchased and why I bought them.
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