~ Kim Kiyosaki ~
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.