What exactly is cash flow investing?
Cash flow is essentially investing cash (or other assets) in order to receive recurring payments - typically monthly or quarterly. These recurring payments provide the cash flow investor with a return on investment.
Cash flow investments generally include a cash flow return and an increase in value (appreciation). This tutorial explains the Cash Flow Definition with best examples.
Cash flow investing: could it be the right thing for you?
It’s pretty much a given that we’d all like to find the ideal investment route, the singularly perfect way and place to put our money and then sit back and look forward to a great life and rich retirement.
Could that solution be the concept known as cash flow investing? After all, as you’ll learn below, observing its techniques offers a good chance of consistent positive performance not subject to the volatility of the stock and bond market.
And can be managed by experts you pick while at the same staying in ultimate control. Considering all that, it seems like the perfect way to build assets and wealth.
Because the principles of cash flow investing can positively power retirement plans as well, we’ll also touch briefly on the simple steps you need to take to make funding these kinds of investments with your IRA and 401(k) possible.
And even why exploring that route for your retirement fund doesn’t necessarily lock you into anything if you change your mind, depending on the types of alternative investments that you choose.
Along the way of our cash flow discussion, we’ll also give you examples using real estate, just one of the investment types available to cash flow investors and recommended as a strong alternative to the traditional stock-market - to illustrate where the numbers come from - and why they can look so good.
Let’s provide an example of cash flow investing using a simple real estate purchase. (Again, real estate is only one of a number of possible investment asset classes, but an excellent one. We’ll have more on this later.) The principles remain the same whether the investment is in residential or commercial real estate.
In this example, someone puts up a lump sum of cash (or invests with other partners) to purchase a property in order to receive the monthly or quarterly income that the rent of the property produces.
The investment property is purchased for $50,000 and the rent is $800 a month.
The gross scheduled income is $9,600 (12 x $800).
We will assume a standard vacancy rate of 8%, thus reducing income by $768.
Assuming a fairly standard 45% expense ratio, we project annual expenses of $3,974.
This nets an annual income of $4,858.
This yields a monthly cash flow of $404.
This is a cash flow return on investment (ROI) of 9.7%.
This, by the way, is an appropriate representative example, since a cash flow return of roughly 10% is a good rule of thumb for those just starting out in terms of what you might be able to expect from this type of investment.
That does not include any appreciation or increase in the value of the property, which is often projected to increase 3-5% per year, on average, due to inflation.
So with this representative example in mind, let’s discuss the overall benefits of cash flow:
Cash flow investing allows you to stop speculating blindly on uncertain returns. It affords realistic protection against volatility associated with certain other asset classes (the best/worst example being the stock market).
Nobody can predict where the stock market will be a year from now, but with cash flow investing, if you’re selective and invest only in low-risk opportunities - with real estate.
For example, highly occupied (85-100%) properties - it’s fairly easy to predict what your cash flow will be because you can estimate your income and expenses within a reasonably accurate range.
Cash flow investing allows you to build a more predictable future for you and your family. Through careful planning and, of course, prudent investment decisions, you can more reliably “set yourself free” by leaving your job and fund both your ongoing existence.
Cash flow investing lets you invest like the rich for “wealth-adjusted returns, which often includes significant tax benefits.” The wealthy tend to have opportunities that others don’t have access to - and investing in cash flow is one of their elemental secrets.
Many of their investments include depreciation and other tax deductions that may defer most or all taxes into the future, letting them (and you) benefit by writing off some of the assets and depreciation - tax deferral that can amount to a huge benefit long-term in any wealth-building program as it opens up growth to the power of compounded returns.
Cash flow investing enables you to take control of your returns. You can invest in what you want (and know) or work with an operator (aka manager of investment) in whom you’re confident, instead of, say, having to hope that the stock market will come through. Also, with some non-traditional investments, you have the power to add value to your investment.
For example, if you face a vacancy in a real estate property, you can increase your marketing or rehab the property to rectify that situation. Under the right circumstances, you may even choose to increase the rent.
Some of these steps do amount to extra costs, of course, but they often can be planned for and they allow you to make improvements in your property (and thus protect or improve your return) by exercising your own free will.
If you own mutual funds or stocks, you’re just along for the ride and your return will be completely immune to any effort you would personally hope to make to improve the value of those assets.
Cash flow investing works for both taxable and non-taxable purposes. The reliable building of income and assets that results from following these principles can be applied to tax-advantaged environments and programs as well, with their benefits thus magnified (for instance, the tax-deferral aspect of IRAs and 401(k)s).
Regardless of your priorities, cash flow investing helps you earn potentially higher and more predictable returns, short-term and long, than traditional investments.
You need to ensure that you are properly diversified across enough opportunities to avoid the risk of “having all of your eggs in one or too few baskets”.
This can be avoided by paying particular attention to how much you invest in each opportunity. If you need advice on how to choose the right investment amounts for you then be sure to consult with your investment advisor.
You do not want to get to the point where you’re encroaching on your investment capital, having to withdraw from your nest egg for expenses, thereby reducing your investable funds, your future earning power and your wealth.
The simple way to mitigate this is to carefully forecast your needs and plan ahead to generate the cash flow you’ll require before you leave your job or retire.
You need to constantly work on optimizing your investment decisions by staying current on the economy and economic data, networking, reading other materials like this, investigating investment courses - and being flexible and resilient enough to learn from your experience.
To avoid lack of liquidity - which is to say, finding yourself with the inability to take advantage of strong investment opportunities as they come along - plan ahead to avoid over-allocation of your total investment pool.
Finally, while cash is normally a great thing to have, for the cash flow investor, it isn’t. Having too much idle cash (other than what’s necessary, of course, for day-to-day operations and emergencies) instead of keeping it in working investments comes with an opportunity cost that can and should be avoided.
Why we like real estate.
As we’ve noted, there’s a world of choices once you’ve decided to focus on alternative investments that deliver recurring payments. With research and diligence, cash flow success can be achieved with investments of many types, both “niche” and normal. We certainly have investigated different asset classes.
. . but on balance we believe that, if it’s appropriate for your investing goals, consistent, predictable and positive results can flow from making real estate the primary asset class in which your cash flow assets are invested.
To begin with, a successful real estate investment by its nature can provide a number of ways to make money — from predictable monthly cash flow to appreciation in the property itself to the tax benefits that real estate provides.
In addition, real estate allows you to make money one more way, through debt buy-down. You can borrow money against your holdings, and long-term, if you’re paying off that loan with the cash-flow income you’re receiving from your tenants. You’re making money on your investment without anything having to come out of pocket.
Real estate, then, allows you to make money four ways.
Real estate is a proven method for building wealth, with more millionaires having been made through real estate than any other wealth-building medium in the world. Long-term real estate ownership historically has proven to be a strong vehicle yielding high appreciation, often far superior to other retirement asset choices.
Further, modest real estate investments (i.e., $25,000 and up) can be “shared” via syndicated participation in larger real estate investments that would normally be out of the reach of smaller investors.
Careful selection of real estate investments affords realistic protection against volatility as compared to certain other asset classes (and certainly compared to stock-based holdings).
For instance, if you are selective and invest only in low-risk real estate opportunities - let’s say 85- 100%-occupied residential properties - it becomes fairly easy to project what the year’s net cash flow from rentals will be, as you can usually predict expenses within a certain range - this in contrast to being at the call of the fluctuations and higher risk of other investment classes.
Real estate is a diverse asset class affording a variety of opportunities serving different investment objectives and also allowing the possibility of anticipating and adapting your investment mix as the nature of the real estate market changes over time.
Unlike traditional market-based assets, real estate is a tangible holding. As we’ve seen, stock exchange-based holdings do not represent a hard asset, and can be subject to the pricing and whims of the market, sometimes emotional and often not predictable. Contrarily, the floor on a hard real estate asset doesn’t usually go to zero.
As we’ve demonstrated before in our discussion of non-traditional investments, with real estate in your portfolio, you have tangible power to add value to your investment.
Real estate notes:
Real estate notes, or mortgage notes, are ideal for investors who want to own real estate without the hassles of traditional property ownership. Instead of buying an actual piece of property, investors buy the loans or notes, that is secured by a piece of residential or commercial property.
Notes have a wide range of entry points, making them accessible to a broad range of investors. Like every investment, what would make the most sense for you depends on what you’re trying to accomplish, how long you have to accomplish it and your own risk tolerance.
This type of investing is specifically appropriate for those who want to invest in using their retirement funds.
Real estate cash flow investing
In real estate and in cash flow investing generally - how do you find the best investments and whom should you choose as advisers and partners?
In our summary to this blog, we’ll mention again the importance of constant networking and learning as you develop and manage your investment program moving forward. There’s no better guide to success than education and learning from your own and others’ experiences - and there are many ways to do that.
However, it will be the quality of the people you run into and seek out and with whom you work as you move along your journey of cash flow investment that, bottom-line, will have the greatest impact on the success of your efforts.
It’s a general truism in business, and we would say most important in the selection of investments, that the deals you make aren’t as important as the people with whom you make them.
To narrow it down, for now, let’s again take real estate. We have made the case that real estate is something you should investigate and that in our own actions and through the advice and techniques we’ve given to others, the rewards have been substantial - but one lesson we have learned and that guides us in everything we do is that WHOM you invest with matters more than WHAT you invest in. It’s as simple as that.
Integrity and performance are that important - and this philosophy goes way beyond real estate, extending to every participant at every stage in the process of building and operating your program.
Integrity is a characteristic hard to spot (and here’s where your networking and personal experience will eventually guide you to the right people), but a true comfort once identified.
Performance is identified and measured in a myriad of ways depending on the nature of your investments and what stage you’re in - but using real estate as an example once again, performance is evidenced in the process of selecting your investments from the many which will (eventually) be pitched to you.
We can vouch from our years of experience that there will be many fine players along the path of creating and investing in your cash flow program, and we trust it won’t be hard for you to find individuals and firms with competence and integrity to serve as your partners, suppliers, and advisers.
The search for these qualities is something you absolutely never should lose sight of.
We abide by an investment philosophy borne out of historical analysis and actual observed results - that cash flow investing can allow you to earn more predictable returns that significantly outperform the long-run average of the stock market. That, in turn, will lead to strikingly increased long-term wealth.
So now you get a sense of why these types of return are typically reserved for the wealthy. The point is; this is how the wealthy invest! You can, too. We’ve alluded to two types of investors - active and passive. What are they, and what’s right for you?
As with many decisions in life, once you’ve made the jump into cash flow investing, you have the choice of becoming an “active” or “passive” investor.
The definitions of these two levels of involvement are intuitive, and based on your available time, past experience, your roll-up-your-sleeves-and-get-involved-in-all-decisions nature, and your self-confidence when it comes to real estate matters, the choice will probably be easy.
An active participant seeks out alternative investments where he/she has full control - for example, in buying a single-family home for the cash flow it offers, the active investor takes title to the property and assumes all management activities (or hires a property manager) as well as all decisions relating to financing and selling the property.
This takes time and attention, magnified for a multi-property portfolio. Active investment is thus best suited for people with the time, detailed knowledge about a specific type of investment and/or who wish to retain full control.
A passive participant invests in alternative investments that are managed by someone else, hiring experienced operators (syndicators) to handle the assets.
In buying that same single-family home, he/she may do so using a buy-and-hold of a pool of homes that are managed by an experienced operator in exchange for management fees and a split of the profits.
The operator/manager is given full control of budget, spending, and decisions on which properties to buy, on structuring the investment opportunity and on the financing and selling of the property.
The key to successful passive investing is to make sure the operator(s) hired are experienced in that type of asset or property.
Passive investing is best suited for persons without the time or the expertise to get deeply involved (or who just choose not to take on that responsibility) and who are willing to invest in an opportunity managed by others with full day-to-day decision-making powers, thereby handing the control over to an experienced operator.
The decision on the depth of involvement is yours, though we tend to recommend that the starting real estate investor strongly consider a more passive entry into this new world. This can, of course, change over time . . . and the decision need not always be based on an investor’s industry knowledge or confidence level.
We are proponents of and committed to passive investing, as it has proven to be the best fit for us after years of investing.
While there are pros and cons to both approaches, definite factors often augur in favor of passive investment:
Passive investing allows for more diversification. Operators with specialized experience can be “hired” across various asset classes and geographies, allowing passive investors to be much more diversified than active investors. You gain diversification along with expertise by investing with experienced operators.
Passive investing obviously makes it easier to accommodate the schedule of part-time investors with jobs, as the operator is responsible for managing the investment.
Passive investing can generate significant cash flow results without doing as much work! Most of the work is upfront in evaluating the property and the operator.
Passive investing allows you to leverage other people’s credit. This allows you to invest in multi-million-dollar properties where your credit doesn’t qualify you but someone else’s does, opportunities that you might otherwise never be made aware of.
Getting involved on this basis has no effect on your credit rating. Most passive investments accept retirement accounts, with the creation of a “self-directed” account and then the transfer of funds from the existing retirement account, which is easy to do. More on that shortly.
It is vital that you define your cash flow priorities, your goals and your activities with a long-term plan.
By now we hope we’ve begun to convince you that focusing on a cash flow investment program, one that utilizes alternative investments and places you in an active a mode as you feel fits your time and predilections, is the beginning of a successful plan to help you escape the corporate world, to enjoy life and, if you wish, to build a comfortable retirement plan.
It is all that - but true success and a smoothly working investment program begins and continues with a long-term plan.
Plans can be simple or they can be complex, but they all should involve defining your monthly cash flow goals for living expenses, for retirement and for any “extras” in life, and then evaluating and planning out a cash flow program that delivers the right amount of income ideally at the right time.
This is possible by choosing investments offering monthly or quarterly payments at the right times and with the right time horizon to match your budgeted expenses and also, ideally, delivering income over and above those foreseeable expenses for reinvestment purposes.
We believe cash flow is king and it can change your life with the right moves and the right effort to find the right investments . . . with the right plan.
The rules governing cash flow investing in a retirement plan differ a bit from non-retirement plans, but observing them amounts to little restriction in your ability to benefit in every way we’ve described so far.
There are three - only three - non-traditional, alternative investment categories excluded legally from investment in a self-directed retirement plan - collectibles, life insurance and stock in “S” corporations.
One more restriction: you, your IRA fiduciary and certain family members cannot do business with your IRA (sell services to or live in an investment property, etc.) - essentially all lineal relatives (parents and grandparents, children and grandchildren) and their spouses.
As we note, there are few and mild restrictions compared with the immense benefits of “investing with the wealthy” in retirement plans.
Summing it all up.
We hope you’re intrigued by what you’ve begun to learn about “how the wealthy invest” and how many of them do so well in growing their assets and wealth by following the principles of cash flow investing.
We’ve reviewed the basic tenets of the technique, and discussed why, although the range of acceptable investments is wide, we’re fans of real estate for both those starting out and experienced cash flow investors.
We hope you understand that these types of investments are available in relatively reasonable minimum investment amounts (starting at $25,000).
We leave you with the reminder again that your success with cash flow investing never stops benefiting from education and networking to share in the experience of others and find new investment opportunities.
Their purpose is purely networking and information exchange, with profit motives and sales pitches, strictly prohibited. We hope you don’t wait long to take advantage of this impressive investing approach. Regardless of your chosen investment path, we wish you good luck and successful investing!