In the world of investing there are primarily two things people invest for, capital gains and cash flow. What’s the difference?
Capital Gains – Capital gains is the one-time profit you make on the sale of an investment. For example, you buy 5 shares of a stock for a total of $100. Those shares go up in value to $150. You decide to sell your shares. The $50 profit you make from the sale of your shares is capital gains.
The same applies to real estate. You buy a house for $100,000. You fix it up and sell it for $140,000. Your $40,000 profit when you sell the house is capital gains.
In order to realize capital gains, you must sell the asset. You can also have a capital loss if you lose money on the sale of the asset. A capital gains strategy assumes an appreciating, or uptrending, market. In order for you to make a profit the asset has to go up in value. Someone must pay you more than what you paid for it.
Cash Flow – Cash Flow is an on-going stream of income you receive from an investment. You may receive this money on a monthly, quarterly or annual basis, depending on the investment. The strategy behind cash flow is to buy and hold, whereas the strategy behind capital gains is to buy and sell.
You buy a stock that pays you a dividend every year. That dividend is cash flow. You loan money to a new start-up business. Each month the business pays you interest on your loan. That interest is cash flow.
Cash flow is what most buy-and-hold real estate investors are after. For example, you buy a six-unit apartment building and you rent out each of the units. Every month you collect the rent, pay the operating expenses and the mortgage, and, if you’ve managed the property well, you end up with positive cash flow. Is it possible to have a negative cash flow? Absolutely. That’s why having a strong financial foundation is so important, so that the investments you make generate positive cash flow.
One of the beautiful things about the Rich Woman formula for financial independence is that you do not need to acquire hundreds of thousands, or even millions of dollars in savings, which is what most people think of when they talk about being financially free and never having to work again. Instead, you simply need to build up your monthly cash flow to be greater than your living expenses. For example, when Robert and I “retired” in 1994, we did not have millions stashed aside. What we had was $10,000 in cash flow coming in every month from our investments, primarily real estate. The beauty was that our living expenses were only $3,000 per month. At that point we were financially free. The cash flow from our investments was more than paying for all of our living expenses.
One more advantage of focusing on cash flow is that it eliminates the fear of running out of money. One fear I hear from people who have retired is, “I don’t know if the money I have set aside for retirement will be enough to last through my retirement.” By accumulating assets that provide a monthly cash flow, money comes in every month until you decide to sell the asset(s).
What are the two favorite words of a Rich Woman? Cash flow. A financially secure and independent Rich Woman loves her cash flow. She knows that she can depend on her cash flow, not someone else, for her financial well-being.