Posted On 27 Jan 2012
Investing for cash flows is better than investing for capital gains.
This may be especially important for the average investor during these difficult financial times. All authorities seem to agree with Robert Kiyosaki’s statement that “we are entering a long and hard financial winter” (Rich Dad’s Conspiracy of the Rich ).
Capital gains investing is gambling. It is possible to win at gambling, but it’s foolish for the average investor to gamble at all in difficult financial times.
Since there are only two kinds of investing and since capital gains investing is unnecessarily risky, investing for cash flow is better because it’s much less risky.
Taxes are another important reason why investing for cash flows is better than investing for capital gains.
Taxes are paid on earned income, portfolio income, and passive income.
It’s good to have any kind of income! However, the problem with earned income, which includes income from a job or a retirement plan, is that it is taxed at the highest rates. If you flip real estate properties or buy and sell stocks and hold those assets for less than a year, the money you make will be taxed as earned income.
Portfolio income most often comes from capital gains. If, for example, you buy stocks or real estate low and sell higher after holding it for over a year, that is capital gains income that is taxed at 28 percent. The danger, of course, is that the stock or real estate that you purchase will not increase in value at all, which is why investing for capital gains is gambling.
Passive income is taxed at the lowest rates. Suppose, for example, that you purchase an apartment building that, after expenses, puts money into your pocket every month. Your income from it won’t only be taxed at the lowest rates, but there are ways to reduce even that tax exposure such as amortization, appreciation, and depreciation.
Assuming that you do your due diligence in advance, you will have an excellent idea before you purchase apartment buildings what their income will be.
Still, since apartment buildings are not liquid and require intensive management, it’s important to understand exactly what you are doing before purchasing them. After all, a single real estate investment can cost you tens of thousands of dollars.
The point is that, from a tax perspective, passive income is the best kind of income to have. If that’s the kind of income you want, then investing for cash flow is your kind of investing.
Another advantage is that you may be able to invest for cash flows using other people’s money! For example, it may prove easier for you to obtain a mortgage on a $1,000,000 dollar apartment building than on a $100,000 single family home. Why? Folks who lend money understand that there’s a huge difference between owning a shelter for you and your family (see Your House and Increase Your Assets) and a cash-flowing asset.
A mortgage on your home is a liability that takes money out of your pocket. Financially, it is bad debt; whether you rent or buy, shelter is an expense. On the other hand, a mortgage on an apartment building may be an asset if it puts money into your pocket. It may be good debt that is not only tax-free but also your tenants may pay it off for you!
I don’t think that any of this is controversial. Why, then, don’t all investors invest for cash flows?
I don’t know. My guess is that it’s because investing successfully for cash flows is more difficult than investing successfully for capital gains.
To continue with the same example, in general, is it easier to sell a single-family home or an apartment building?
A single-family home. Why? There are many, many more people looking to purchase them than there are real estate investors looking to purchase apartment buildings. That higher demand makes it easier to sell.
Real estate is not a liquid asset, and apartments are more illiquid than single-family houses.
Also, more people understand how to buy single-family houses than apartment buildings.
Furthermore, apartment buildings are usually more expensive than single-family houses.
Therefore, it seems that buying apartment buildings is more dangerous than buying single-family houses.
Well, not exactly: they are only more dangerous to buy for the average investor.
What if you learn how to purchase them? What if you specialize and develop an unusually high degree of financial intelligence about investing in apartment buildings, which is an excellent example of investing for cash flows?
If you don’t get distracted, stick to that one kind of investing for cash flows, and avoid all other kinds of investing (including other kinds of real estate investing such as investing in office buildings or shopping centers), you’ll soon be able to develop a plan that will work well for you.
Why re-invent the wheel? Learn how to invest in apartment buildings for cash flows from those who have already done it. It’s foolish not to learn from the mistakes and successes of others.
For example, Kiyosaki sketches his plan in Rich Dad’s Conspiracy of the Rich. He ignores high-end apartment buildings because there is weak demand to live in them as well as low-end apartment buildings because they are too management-intensive.
Where are safe, clean apartments for working-class people located that have a high demand to live in them? Near great sources of working-class jobs!
Everyone understands that location is the most important criterion when selecting real estate. It’s critical when selecting apartment buildings for cash flows.
For reasons that James Howard Kunstler gives in The Long Emergency, I think that the best location to be a real estate investor in the U.S. in the coming years will be in the Northeast.
The reasons for that include global warming as well as oil depletion. Even if you buy real estate with good cash flows now along, say, the Florida coast or in the cities of Nevada, you may not have to live very long to regret your foolishness!
It’s also critical to take into account where in the market cycle real estate is before making any offers. There are very good books and courses that teach how to do that.
Investing well for cash flows is complicated. In fact, it’s too complicated for most people.
Whether that’s good or bad news for you depends on you. If you are too distracted, ignorant, or unwilling to learn how to do it well, my best suggestion is not even to try.
If you are focused, willing to learn how to overcome your ignorance, and committed to doing it well, my question is, “Why not?” If you have read this far in this post, you probably have what it takes.
Remember, since it’s easier to invest for capital gains than for cash flows, fewer people invest for cash flows. Since fewer people are trying, there’s less competition. Because there’s less competition, the odds of your being successful are automatically increased.
If you are the right kind of person, it’s an excellent way, perhaps even the best way, to become financially successful and independent.