3 Investing Styles for Stocks
You never truly get your diploma in Financial Education.
So you want to be a stock investor. Now you just have to match your investing goals with the right investment strategies… and don’t say your goal is to make money.
As a stock investor, there are three ways you can use the stock market to accomplish your goals:
Capital gain: buy a stock share at a low price and sell it at a higher price – the difference between your buy and sell price is your gross profit
Cash flow: have a stock portfolio that pay out dividends or buy a stock share and option it to earn income for ongoing cash flow
Hedge: buy insurance (options) on your stock share to protect it
All three of these are valid actions. It’s important that you know about these different strategies so you can make smart decisions.
Ask yourself this important question:
“What are my investing goals? Is one of them to increase my net worth? If so, what investments should I buy to accomplish this?”
If stock investors want to increase their net worth with stocks, they can buy shares and hold them in their portfolio, hoping they increase in value. Many people are already doing this through retirement plans such as a 401(k), an IRA, and mutual funds.
However, your goal may be to generate cash flow. You may want to use the strategy of selling options to meet your cash flow goal. Cash flow is valuable to you because it’s how you are able to feed your family and pay your bills. Simply having an asset that increases your net worth does nothing to improve your cash flow situation. That’s why Rich Dad encourages people around the world to think differently and seek assets that give them cash flow.
When you have assets that generate cash flow for you, it can help you now and through retirement. Remember: Net worth doesn’t help you retire; cash flow does.
That’s an important distinction to make. If you are selling options on your stocks, that is cash flow that goes into your income statement. It’s an important addition to your income statement that can transform your life.
Your third investing strategy is hedging. This is also called buying insurance. Hedging is simply a purchase that protects you if something bad happens to your primary investment. So if your goal is to protect what you have, then hedging is the strategy you’ll want to deploy.
Professional and Amateur
The two biggest differences between professional and amateur stock investor are:
1. Amateurs are always going for the capital gain, and professionals go for cash flow.
2. Amateurs are always trying to hedge or protect themselves with diversification, but professionals use option contracts like insurance.
Capital Gains vs. Cash Flow
Maybe you want to buy Acme and you buy it at $100 a share. Let’s say Acme is now worth $200. Now your net worth’s gone up. You have more money than you did before. Your “assets” have grown, but Acme has not given you any income; there’s no cash flow from it.
But suppose you buy a stock that pays you a regular dividend. Now you own an asset that is also adding to your cash flow without you having to do a thing for it. With enough assets like this, you can eventually have the income to do whatever you like right—now or in retirement. In my opinion, that should be the overall goal of investing: freedom of choice and lifestyle.
Today’s typical retirement plans, such as the 401(k), don’t provide you with cash flow. Instead, the focus is usually trying to build a net worth that is large enough to support retirement—and that is very hard to do. Many people are concerned that their money will run out before their time on earth does. Most mutual funds are not created to provide you with cash flow. Instead, they simply add—or sometimes subtract—from your net worth. But they are not giving you income.
For some new investors, this is a difficult concept to understand. We are trained by the media and Wall Street to equate net worth growth with investing success. But let’s look at a familiar situation that illustrates why net worth may not be the best investing goal.
Suppose you have monthly bills of $4,000. Well, having your net worth go up and down isn’t really going to matter. You need to cover these expenses every month. You need income-producing assets to produce cash that helps crack this nut. If you can get $4,000 in cash flow coming from assets, you can be independent of a job. Now, that’s a goal!
That is wealth. Wealth is when you have passive income to cover your $4,000 in expenses. Cash flow is the key to wealth.
If you have a high net worth, you may be rich but you may still have to work. You can be rich in net worth and not be able to pay your bills. You can have a million dollars in a 401K and not be able to cover your monthly-expenses for the rest of your life. But with passive income that exceeds expenses, then you’ve become independently wealthy. In other words, you have enough wealth to be independent from having to work.
Now let’s take a quick look at hedging, which is essentially buying insurance on investments. When you buy an investment such as a house, you certainly don’t want to lose that investment. No matter the reason behind your purchase, it’s important to protect it. If the house burns down, the insurance you bought guarantees that your investment will be safe.
If you bought the house to live in, the insurance will pay for a new one to be built. If you bought it for capital gains, then the structure will be restored so you can sell it in the future. And if you bought it for cash flow, you can get renters back into it fairly quickly.
Buying insurance doesn’t put money in your pocket. It’s an expense. But smart investors protect their investments with insurance.
Those are the three goals and the strategies for investing: Capital gains to grow your net worth; cash flow to grow your income; and hedging to protect your investments.