My top four cash flow investing strategies are purchasing your investments at a discount, leveraging debt to make your money go farther, reinvesting your cash flow earnings and becoming familiar with your tax code.
These four strategies can be applied to almost any style of cash flow investing, although good luck getting a loan to invest in the stock market.
Let’s take a detailed look at how each of these strategies can lead to more cash flow for you.
Measuring Success With Cash On Cash Return
Before we get into the cash flow investing strategies it’s important to know how we measure the success of cash flow investments.
One of my favorite ways to measure my cash flow success is with cash on cash return. It’s basically a measure of how long your cash up front is tied up in an investment. Generally speaking, a higher cash on cash return means you’re getting more cash flow for your money. And it also means that you will be able to acquire more investments faster.
For example if you put $1,000 into an investment and over the next year you get $100 in cash paid out, that would be a 10% cash on cash return. This means it will take you about 10 years for your initial $1,000 to make it back into your bank account.
While cash on cash is not the only way to measure a cash flow investment, it’s one that you should have a standard for. You should know if 10% cash on cash return is enough for your goals, and if it’s not you should say no to an investment with a 10% cash on cash return.
Strategy 1: Value Investing
One of the most famous investors of our time is Warren Buffett. He’s not a cash flow investor, but his most well known strategy, value investing, applies to cash flow investors as well.
Basically you’re just deal hunting. You want to get a discount on your investments. If you believe a particular investment is worth $1,000 then you’d rather pay $900 for it.
When your initial investment is lower, then all your metrics are better, including cash on cash return.
That investment from earlier that was going to put $100 in your pocket after the first year you bought it gave a 10% cash on cash return when purchased for $1,000. That’s $100 / $1,000. But if you bought the same investment for $900, then your cash on cash is 11% ($100 / $900).
You kept $100 in your pocket, which means it will only take you 9 years now to return your initial investment to yourself. This allows you to invest the money again sooner and ultimately build wealth faster.
Value investing in practice
That sounds great, but stocks, businesses and real estate don’t exactly have 10% off coupons or black friday sales. So how do I know if I am actually getting a deal?
When you pair your personal investment standards with proper due diligence, you can have confidence in your ability to spot great value. You should know what your minimum cash on cash return is to accomplish your goals. For me it’s 20%.
If I finish my due diligence and find that I would expect an investment to get me 25% cash on cash return, then I’ve found great value.
Your return number
OK, so what should your standard be? Of course that’s a person to person thing, but I can be pretty confident that your cash on cash number should be at least 2%. Why? Because most long standing dividend paying stocks can get you 2% cash on cash return, and they require no effort from you at all.
I’m guessing you’re not reading this article to help you get 2% returns, though. I can’t tell you what your number should be, but I can tell you how I arrived at my number.
Here’s why I chose 20% cash on cash return:
- Cash up front should be back in my pocket in five years or less
- By repeating this return, I can quit my job in less than 10 years
- My first real estate investment got about 18% cash on cash, my second got about 40% and my third got 30%, so I know 20% is possible in my area.
- 20% gives me plenty of room for errors in my due diligence, meaning I’m very unlikely to lose money.
- I saw others in my investment area using 20% and that gave me a number to anchor on.
Whatever your number, make sure you know what it is and stick to it. Never make an exception.
Due diligence in practice
It’s not even possible to cover every detail of due diligence in one article. Even if you chose an investment type, like stocks, it would be impossible. So I just want to give you some practical advice to make sure your due diligence is up to snuff.
Here is a list of things you must know before buying any investment:
- What will be my monthly and yearly expenses?
- What will be my monthly and yearly revenue?
- How much money will I need to purchase?
- What are my biggest risk factors? What can make this a bad investment?
- If one of those risk factors becomes a reality, how to I prevent my worst case scenario?
- Is there anyone else who has control over the performance of my investment? What kind of person is he or she? Does he or she have a good track record?
- What is my expected return on investment?
You should talk to these people before buying any investment:
- Lender/banker if you plan to borrow money
- Accountant or whoever does your taxes
- Lawyer or whoever advises you in lawful matters
- Any other person who can give you sound advice on the purchase
- Your spouse, partner, family, or any living companion who will be affected by your finances
And be in this kind of mindset while working on your due diligence:
- Be as conservative as you can with your numbers. Add 10% to all your expenses. Cut 10% from all your revenues.
- Assume you missed something the first time you feel like you’re done with your due diligence
- When it’s time to act, trust yourself and trust your numbers. Be confident in your assessment and don’t hesitate to pull the trigger.
Strategy 2: The Power Of Leverage
Now I want to talk about possibly my favorite strategy for new investor, debt. Using debt adeptly supercharges the growth of your cash flow AND your net worth. Let me prove this to you through another example.
Let’s assume you have $100,000 to invest. Here are two things with this money:
- Buy one property worth $100,000
- Buy five properties worth $100,000 each
Disclaimer: Buying five properties would require you to be approved for a $400,000 loan.
Let’s assume all of these $100,000 properties perform the same. All of them have $1,500 per month in revenue and $500 in total expenses. But let’s not forget that you borrowed $400,000 to allow you to buy the five properties. Typical terms on that loan would be 30 years at 5%. This would result in a monthly payment of $2,150.
So what happens to our cash flow in the two scenarios?
- Monthly cash flow for one property is $1,000 ($1,500 – $500)
- Monthly cash flow for five properties is $2,850 ($7,500 – $2,500 – $2,150)
So by leveraging our money and purchasing $500,000 worth of real estate instead of just purchasing $100,000 of real estate we’ve NEARLY TRIPLED our cash flow!
We can see this reflected in our cash on cash return as well.
- Cash on cash return for one property is 12% (12 * $1,000 / $100,000)
- cash on cash return for five properties is 34.2% (12 * $2,850 / $100,000)
Risks of leveraging
Have you created additional risk in order to increase your cash flow? Many would say yes, I’m not sure I agree. In some ways you’ve increased your risk and other ways you’ve decreased your risk.
The biggest risk is if your revenue decreases too much or your expenses increase too much. Let’s look at the same example with slightly different numbers.
Let’s assume each property’s revenue decreases to $1,200 per month and and their expenses increase to $700 per month. What happens to the cash flow picture?
- Monthly cash flow for one property decreases to $500 ($1,200 – $700)
- Monthly cash flow for five properties decreases to $350 ($6,000 – $3,500 – $2,150)
Obviously, using these numbers you are better off just buying the one property outright.
This is why your due diligence process is so important. You need to foresee as many factors as possible that can affect your revenue and expenses and plan for these scenarios.
It’s clear looking at these numbers that leveraging debt creates a more volatile investment. You’ll realize higher highs, but when you experience the lows they will hit harder.
Risk mitigation through leveraging
Many folks only like to talk about the risks of leveraging. The volatility. The debt payments that will still be there if your investment flops.
But few talk about leveraging as a way to mitigate risk. I would say that leveraging debt is one way to diversify your investment portfolio. We can see that quite clearly with the example we’ve been using.
With one property, your investment portfolio’s performance is completely dependent on the performance of that one property. If that one property has a major repair, or a long standing vacancy, or a really bad tenant that doesn’t pay rent, you could be looking at a loss for several months.
But if you have that scenario happen with one of five properties, then the other four can pick up the slack and you will probably still remain profitable during the tough time.
Many are quick to point out the risks of utilizing debt in investing, but often we forget that it can also be used to create a protective barrier for us.
Strategy 3: Reinvesting Your Cash Flow
One of the reasons I prioritize cash flow in my investments is so my investments can support my life. But if you keep 100% of the cash your investments give back to you, then you’re limiting your potential to earn.
The most powerful force in investing is that of compound interest, and if we want our cash flow to explode we should reinvest as much as we can.
There’s a principle laid out in wealth building that says to save and invest at least 10 percent of your earnings. Perhaps you’ve been doing that and you have several thousand saved and ready to pounce on an investment (at a discount price of course).
And now let’s imagine that you find something and invest. And now you’ve got some money coming into your bank account every month. What should you do with that money now? Well you were doing pretty well before you bought the investment, you can probably do just fine now.
If you begin putting that cash flow back into another investment then you can improve your returns over time, and increase your cash flow even further.
In the stock market it’s called dividend reinvestment, and it’s a pretty common practice among savvy investors. Well real estate and business investors can do the same and reap the same rewards.
A reinvestment example
Let’s see the power of reinvestment through an example. Let’s consider a business worth $100,000 that we buy outright with no loan.
The business is making $25,000 yearly income. The easiest way to see the difference is to assume the yearly income remains stable and stagnant over time.
So without reinvestment your yearly income will continue to be $25,000 forever.
But let’s assume you want to use that income to create additional growth over time and you decide to allocate half of your income every year to another investment. And let’s assume your cash on cash return for that investment is 10% (very modest).
Year 1: Your first year you would reinvest $12,500 of your cash flow and that investment would generate an additional $1,250 in cash flow for the next year.
Year 2: Your income in year 2 would be $26,250. This would allow you to reinvest $13,125 which would generate an additional $1,312 in cash flow next year.
Year 3: This year’s income is $27,562. You reinvest $13,781 which increases next year’s cash flow by $1,378.
Year 4: Income is now $28,940. You will reinvest $14,470 generating an additional $1,447 in cash flow next year.
Year 5: Income is $30,387. You reinvest $15,193 generating an additional $1,519 in cash flow next year.
So after 5 years reinvesting 50% of our income our cash flow is now $31,906. Compare this without any reinvestment where the cash flow remains at $25,000. That’s about 28% more cash flow after 5 years!
Strategy 4: Tax Avoidance
The longer I’ve been in the investing game, the more attention I pay to my tax burden. As far as I know, every country in the world puts a tax on their citizen’s income. And those taxes can have a huge impact on your wealth over time.
In my articles highlighting the return potential of various investments, real estate stands apart from the pack as having the best tax avoidance capabilities. And businesses also benefit from several tax benefits.
Here’s the deal.
Real estate and businesses allow you to lower your taxable income through deductions of all kinds. Repair costs, cost of supplies, depreciation of real estate and business spaces, interest paid on loans, meals and vacations on business time; All these things can be deducted from your taxable income.
The book that first opened my eyes to how powerful tax awareness can be for building wealth was Tax-Free Wealth by Tom Wheelwright (this is an affiliate link. I’m recommending this book because it made me wealthier, and I believe it can do the same for you).
I hear people hating on the wealthy for their ability to avoid taxation, but what Tax-Free Wealth showed me is that the government writes the tax rules in order to manipulate the behavior of investors. The government creates opportunities for an individual to lower their tax burden so that intelligent investors (like you and me) will behave in a way that avoids taxation.
The wealthy are creating jobs and affordable housing for regular citizens and the government rewards that by offering tax breaks. It’s a win-win!
The book is aimed mostly at real estate investors, but it does a great job of showing how anyone can start to mold their investing strategies to take advantage of tax breaks.
If you’re ignoring your taxes, then you’re leaving money on the table.
I’m always looking for new cash flow investing strategies, and there are certainly strategies that aren’t on my list, but the four I’ve listed are my best of the best, cream of the crop techniques for increasing cash flow.
Find a great deal, take on debt to make your money go further, reinvest your earnings and educate yourself to take advantage of your tax laws. Pair these things with meticulous due diligence and no hesitation to act when an opportunity presents itself.
Do this and your cash flow will start to grow.