The greatest benefit of passive investing is the freedom it gives you. A steady flow of income generated by your real estate investments is the basis of your prosperity. It allows you to build wealth from a secure footing.
When you’re investing, should you focus on assets that generate income, or should you focus on building a high net worth? While both are important, it’s cash flow that gives you the freedom to leave your job, pursue new opportunities and build a solid foundation for your future.
Why You Should Focus on Cash Flow
As a passive investor, you may wonder if you should focus on increasing your net worth or improving your cash flow. In our view, cash flow is the true marker of financial success.
Cash Pays Your Regular Expenses
Cash flow is the measure of how much money you have to spend on necessities, luxuries and investments or savings. If you have high cash flow, you have more to spend on all these things. Simply put, cash flow pays the bills.
Businesses that have high cash flow are stronger than those that have high net worth because they can avoid debt and attract investors. Similarly, your personal financial situation improves when you can use cash to avoid debt, pay your creditors, pursue more opportunities and build your future.
Net Worth Is Not Liquid
High net worth is a good snapshot of your financial situation, but it is not liquid like cash. If you need cash quickly for any reason, a high net worth won’t save you. If your net worth is tied up in a home, for instance, it’s an all-or-nothing situation. You can’t sell part of a property. Are you going to sell off your assets every time you need cash? Eventually, you’ll run out of illiquid assets and have to start over. A positive cash flow means being able to take that trip, buy that business or meet an unexpected expense with ease.
Net Worth Can Change
Your net worth can change as markets and economic situations change. If a property increases in value, that’s great news, but it doesn’t increase your immediate ability to spend or save more. Many gains in net worth are so-called paper gains that don’t affect your income. Also, these assets can drop just as quickly as they rise.
Cash flow is tangible. It’s money you can use. It’s also more reliable than net worth. Once you have a flow of cash, it tends to remain steady. This is especially true if you have several income streams. You can take in enough income to offset occasional dips in cash flow.
It Offers More Stability
A high net worth doesn’t mean you’re financially stable. You can have a high net worth but be running through your cash every month to stay afloat. Eventually, you will hit bottom and have no cash. If you sell your assets, how long will it take for that money to run out?
What if the opposite is true? Someone with low net worth and high income is in a more secure situation. You can pay your living expenses and avoid going into debt. You can always work on further passive investing and wealth building once your cash situation is stable.
Cash Flow Is Freedom
Net worth gives you a solid foundation for the future, but cash flow gives you the freedom to live your daily life. Dividends, passive income or the proceeds of asset sales all combine to create a steady flow of cash that takes away your need for a job.
Wealth building starts once you have an established income. Cash flow gives you the freedom to make more investments, buy more property and continue to build wealth for the future.
High Net Worth Can Be an Illusion
Although more than half of American families are homeowners, a large number of them have low net worth. Their entire net worth is in their homes. To make matters worse, they frequently have low or negative cash flow. For these families, their high net worth is an illusion because they aren’t investing in income-generating properties.
It’s More Attractive To Investors
There’s a reason investors don’t judge a company by its net worth. When they’re looking for their next investment, they look for cash flow. Like a person, a business can have a high net worth and an insufficient cash flow. That signals trouble because a business that has low cash flow usually ends up in debt and unable to expand. A business with a high cash flow has the money to compete with other businesses, acquire other companies, avoid debt and continue expanding.
If you look at your financial situation as a business, you should judge it by the same terms. Would you be a good risk for an investor? Having high cash flow means you can meet your personal operating expenses with plenty left over.
Cash Flow Is Predictive
Your net worth is mostly about your past financial life. It can tell you what you did with your first investments. Cash flow is predictive of your future. If you’re on the right track, your cash flow will steadily increase every year. A solid cash flow is a good indicator that you’ll continue generating income for years to come.
You Can Pursue New Opportunities
With a cash flow cushion, you can pursue other investments or ideas that interest you. You can feel confident about purchasing more real estate or other assets. Cash flow is the key to maximizing opportunities.
Asset-Producing Investments Have More Value Than Personal Property
Your asset mix may include dividends, capital gains, interest-bearing accounts and property rents. These are all asset-producing investments. Any property that helps you generate income can also fall into that category. The more investments you have, the more your assets will grow and the wealthier you will become.
Personal assets don’t generate a cash flow. Personal property includes your personal home, vehicles, jewelry and other assets. These assets may have value, but most of them don’t appreciate in value. They may even lose value. Investing too much money in personal property can be an unwise use of your money.
Net Worth Is Subjective
Everyone has a different opinion of what a good net worth is. There is no hard and fast way to determine if your net worth is too small or just right. Most people would say, for instance, that a million dollars is a good solid net worth. It is, but what if you’re tied up in a million-dollar mortgage? Does it still count? Some people would say yes, and others would say no. People can argue about this all day.
Cash flow is objective. There’s no argument. You either have enough money to meet your expenses, or you don’t.
It’s More Enjoyable
High cash flow is also more enjoyable than a high net worth that’s locked away and untouchable. High cash flow allows you to meet your expenses without worry, travel, enjoy life and support your children or favorite charities. It’s the reason you chose to be a passive investor. A high cash flow lets you enjoy the results of your investments.
When To Pursue High Net Worth
Naturally, there are times you should pursue assets that will add to your net worth.
You’re Just Starting Out
When you start out on your passive income journey, you may have limited funds to work with. Most people in this situation prefer to buy assets that can give them a solid foundation of wealth. For most of us, that means property. Real estate is usually the first income-generating asset people buy when they’re creating passive income. Starting this way can help you start with a strong foundation.
You Need To Diversify
If you’ve focused most of your effort on income-producing acquisitions, you may have neglected to add to your long-term growth. You might need to spend more time on your retirement plans. If you have amazing cash flow, that’s great. Use that money to invest in wealth building for your future.
You’re Getting Older
As you get older and closer to retirement, you may want to cash out of your investments and properties. If you have assets that have steadily appreciated in value, selling them will give you a nice chunk of cash to fund your remaining years. In this case, high net worth allows you to enjoy life without the headaches of managing your properties.
The Bottom Line: A Diverse Portfolio Is Best
Your portfolio should include a good mix of income-generating assets and those that lead to long-term growth. Start by choosing assets that produce an income. Then, focus on building your net worth.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.