The Two Types of Investment Income

Making money through cash flow versus capital gains

Most people make their money by working a job and collecting a monthly paycheck. People do this because it's what they are taught to do, and it is also feels safe and secure. The rich, however, don't make their money from a job or a salary. Instead, they make their money from their investments.

The best way to make money is as an investor, but the question is, how do you make that money? If your monthly income as an investor does not come from a job, a salary, or you working, then where does it come from?

It comes from you putting your money to work, instead of you working for money. It comes from investing your money where it will deliver a consistent return. Different investments produce different results. The question is, what results do you want?

There are two primary outcomes an investor invests for:

Investor income #1: capital gains

Capital gains is the game of buying and selling for a profit. You have to keep buying and selling, buying and selling, and buying and selling...or the game and the income stop.

Capital gains occur, for example, when you buy a share of stock for $20. The stock price goes to $30, and you sell it. Your profit is called capital gains. The same is true with real estate. You buy a single-family house for $100,000. You make some repairs and improvements to the property, and you sell it for $140,000. Your profit is termed capital gains. Any time you sell an asset or investment and make money, your profit is capital gains. Of course, there are also capital losses. This occurs when you lose money on the sale.

The problem with capital gains

Unfortunately, many “flippers”—people who buy a real estate property and quickly turn around and sell it for a profit, or capital gains—got caught when the real estate market turned down. The mindset for many was that the market would continue to go up. When the market reversed and crashed, the properties were no longer worth what the flippers bought them for, and there were no buyers to flip the properties to. This is one reason why we have seen so many foreclosures and people just walking away from homes.

Most investors today are chasing capital gains in the stock market through stock purchases, mutual funds, and 401(k)s. These investors are hoping and praying the money will be there when they get out. To me, that’s risky.

As long as market prices go up, capital-gains investors win. But when the markets turn down and prices fall, capital-gains investors lose.

Investor income #2: cash flow

Cash flow is realized when you purchase an investment and hold on to it, and every month, quarter, or year that investment returns money to you. Cash-flow investors, unlike capital-gains investors, typically do not want to sell their investments because they want to keep collecting the regular income of cash flow.

If you purchase a stock that pays a dividend, then, as long as you own that stock, it will generate money to you in the form of a dividend. That is called cash flow. To cash flow in real estate, you could purchase a single-family house and, instead of fixing it up and selling it, you rent it out. Every month you collect the rent and pay the expenses, including the mortgage. If you bought it at a good price and manage the property well, you will receive a profit or positive cash flow.

The cash-flow investor is not as concerned as the capital-gains investor whether the markets are up one day or down the next. The cash-flow investor is looking at long-term trends and is not affected by short-term market ups and downs.

The advantage of cash flow investing

The best thing about cash flow is that it's money flowing into your pocket on a continual basis whether you're working or not. It is your money working for you. And generally, cash-flow investing is based on fundamentals that aren't as susceptible to market swings like capital-gains investments, which means that even in bad times, money still flows into your pockets.

Additionally, cash flow is what is known as passive income, which is the lowest taxed type of income. This is not always the case with capital gains taxes, which vary depending on the type of asset you've invested in and how long you've owned that asset. In some cases, the taxes can be very high.

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