There are two types of investors. Cash flow investors and net worth investors.
I am a cash flow investor.
And I’m here to tell you why seeking to maximize your cash flow will get you to financial freedom faster!
What Is Net Worth?
A person’s net worth is just the current value of all their assets minus the current value of all their debts.
Assets can include anything you own (house, car, fancy computer, stocks, some other ownership of a company).
Debts are whatever money you owe to someone else (home mortgage, student loan, some other kind of loan).
What does it mean to have a $1 billion net worth?
One misconception I see a lot online is that having a $1 billion net worth means you have $1 billion in disposable income.
That simply isn’t true.
When someone has a large net worth, very little of it will be kept in a bank account. Most of that value is held in various assets ranging from real estate to ownership of various companies.
In order to access all that money, it would likely take years to sell off those assets. And there’s a very good chance the assets wouldn’t actually sell for the amount at which they are valued.
Ultimately, having a $1 billion net worth means you don’t actually have access to $1 billion dollars.
How do you buy something with net worth?
People buy most things with cash and cards. And a part of your net worth is the amount of money sitting in your bank accounts.
So a high net worth individual will buy most things with their cash and cards. But the cash and cards only give them access to a very small percentage of their net worth.
There are only two other ways to purchase something that will allow a person to better leverage the power of their net worth:
- Get a loan
- Liquidate assets
You can get a loan, often using the value of your assets as some form of collateral. Or you can get cash by selling some stocks or real estate you own.
What Is Cash Flow?
Cash flow is normally measured on a month to month basis.
It’s the average amount of money coming into your bank accounts each month minus the average mount of money going out of your bank accounts each month.
Cash flow doesn’t care about the net worth held in assets that are difficult to sell. It only cares about the money in your bank account.
Why Be A Cash Flow Investor?
In a word: time. Cash flow investing gets you to financial freedom and retirement faster.
There are two reasons a person wants to be wealthy. Either they want the freedom that having money provides, or they want to be admired by others.
I’ll assume you want to be wealthy for the freedom that having money provides.
So if you want to reach financial freedom as fast as possible, then I say you can’t afford to be a net worth investor. You need money coming into your bank account every month.
Race to quit your day job
The first leap in the path to financial freedom is trading some of your financial success for freedom of time. In other words, quitting your job.
Collecting assets that put money in your bank account each month is the fastest way to do that.
You need to be able to cover your cost of living in order to get rid of your paycheck. By accumulating cash flowing assets, you will increase your net worth while also giving yourself the means to survive without a job.
Race to retirement
Again, the next big step in the path to freedom is to remove yourself from the money making equation.
There are two ways to do this:
- Invest in no effort cash flowing investments like dividend stocks or
- Pay someone to do the stuff you don’t want to do
Cash flow investors will take the second option.
The problem with no effort investments is they’re too slow. You’re lucky to get a 5% cash return on your investment for no effort investments.
For reference a 401k has a 0% cash return. You get no cash in your bank account from your retirement accounts.
The best cash flow investments are things like businesses and real estate. You can often get 20% cash return on your investment or better. The reason why most people don’t opt for these investments is that they are a lot of work and require specialized knowledge.
OK so obviously I think that cash flow is the way to go for those trying to achieve “retirement” as fast as possible while creating wealth.
But what about after you retire? Should you pivot to focus on net worth?
It kind of depends on your goals, but my opinion is that your priorities should start to shift towards wealth protection.
You still need to maintain a healthy cash flow to support the life you want to live, but beyond that I believe it’s more important to mitigate risk.
That’s not to say cash flowing investments are risky!
In fact, for a seasoned real estate investor, buying real estate is possibly the safest investment. And real estate is certainly a great investment for cash flow.
What I’m saying is that after retiring, it’s more important to minimize the risk of losing your wealth than it is to maximize cash flow OR net worth.
A Word About Diversification
The advice I hear all the time about how to minimize risk is “diversify.”
I don’t like that advice very much.
To me diversification is what you do if you don’t know much. It’s reasonable advice for an uneducated investor.
But it’s like telling everyone to get a liberal arts degree because you can do anything with a liberal arts degree. Better to be qualified for everything in case a major shift in the job market happens, right?
But who has more risk coming out of college? Someone with a generic liberal arts degree, or someone with a specialized degree like Nursing or Structural Engineering? I’d rather have a specialized degree.
The same is true in investing. You’re better off having specialized knowledge of a small section of the investing world.
You don’t minimize risk by diversifying, you minimize risk by understanding your investments.
And sometimes a certain measure of diversification is a wise move. But not always, and certainly not if you don’t understand where you’re money is going.
Here’s the long and the short of it.
In order to retire, there is a cash flow number that you must reach. But there is not a net worth number you must reach.
Your net worth can be zero, but as long as you have enough money coming into your bank account every month you can cover all your expenses with ease.
I believe that we should all be cash flow investors to create financial freedom and time freedom as fast as possible.