To cash flow in real estate, you could purchase a single-family house and, instead of fixing it up and selling it, you rent it out. Every month you collect the rent and pay the expenses, including the mortgage. If you bought it at a good price and manage the property well, you will receive a profit or positive cash flow.
The cash-flow investor is not as concerned as the capital-gains investor whether the markets are up one day or down the next. The cash-flow investor is looking at long-term trends and is not affected by short-term market ups and downs.
A Third Way Investors Invest
There is a third way investors invest, and that is called a hedge. A hedge is like insurance. It is used to offset possible losses.
For example, with every rental property I own, I create a reserve account. The reserve account ensures against unforeseen repairs and drops in income. The money is set aside to cover emergency expenses or a loss of rental income in case the tenants move out. It is a hedge against those losses.
We have a large commercial property with one tenant. If this tenant moves out before their lease expires, we are left with a gaping hole in our income which we use to pay our mortgage. We would then be at risk of losing the property. The reserve account we have on this property is a hedge, or insurance, that if that happened, we could still pay the mortgage.
Silver and gold are two other examples of a hedge. Robert and I buy gold and silver not because we think the price will continue to rise, even though we do think that will be the case. We buy it mainly as a hedge against the dollar losing its value. Historically, when the dollar declines in value, people look to real money, such as gold and silver. Generally, when the dollar goes down in value, the price of gold and silver goes up. To us, gold and silver are a hedge against the devaluing dollar. We buy gold and silver to offset possible losses of the dollar.
Stock options are another hedge that investors use. A stock option is the right, but not the obligation, to buy a stock (a call) or to sell a stock (a put) at an agreed-upon price within a certain time period or on a specific day.
A stock option is a hedge because, if you buy a call option, you are betting that the price of that stock is going up. The price of the option is a small fraction of what the actual stock would cost you to buy. For instance, the stock may be selling at $30 per share, but the option might cost only $1. If the price of the stock goes down $10, then you forfeit the cost of the option at $1 per share instead of losing $10 per share. The option is a hedge against possible losses. Of course, if the stock does go up, then you can use, or exercise, your option and buy the stock at the lower agreed-upon price. Stock options are a science all to themselves.
Two Words You Should Grow to Love
Capital gains, cash flow, and hedges all have a place in the world of investing. I use all three. However, to accomplish my goal of financial independence and infinite wealth, my two favorite words when it comes to money are:
CASH FLOW
Cash that flows in every month without you working for it is produced by investments, or assets, generating cash flow. That cash flow is called passive income. That’s not to say you won’t also use investments to produce capital gains or as a hedge. They are all important. The primary focus in building infinite wealth, however, is on cash flow. Why? Three reasons:
1. Most people cannot save their way to retirement today. It’s not easy—in fact, I would say it’s almost impossible—to save the amount of money you will need to retire. Unfortunately, way too many hardworking people who were planning on retiring in the next few years are finding out that they cannot afford to do so. Too many people will be forced to work, literally, until the day they die.
A better focus would be to acquire the amount of cash flow, or passive income, you want per month that will last as long as you own the investment.
For example, when Robert and I retired back in 1994, we did not have a huge amount of money in savings. As a matter of fact, we had very little in savings. Our stock portfolio was almost nonexistent, and we did not have mutual funds or a 401(k). What we did have was $10,000 per month in cash flow coming in every month from our investments, primarily real estate at the time. Our living expenses, on the other hand, were only $3,000 per month. At that point, we were financially free. Our passive income was greater than our living expenses. My point is, it wasn’t millions. It was $10,000 per month. That, and more, is very doable today.
2. I like control. I do not like to invest in things where I have no control, especially when it comes to my money. I am not a stock trader or a flipper (one who constantly buys and sells property). I am not good at timing the highs and lows of the stock market or the real estate market. I’m just not that smart. My cash flow from my investments is not dictated by the daily fluctuations of the market. I cannot control the markets. I can control my rental properties. I can control my businesses. The majority of stock shares that Robert and I own are shares of companies we own. And although I may not be able to control the oil production of our cash-flowing oil wells, I can pick up the phone and talk with the owners of the company at any time.
3. I want to determine when I retire or, better yet, have the choice to stop working or not. I can achieve my goal of building up my cash flow to equal or exceed my living expenses much quicker than I can amass a set amount of money to live on for the rest of my life. Cash flow also frees me up to get on with my life and do what I really want to do, not dictated by the constraints of money.
Cash Flow Breeds Cash Flow
Cash flow breeds more cash flow. My first cash-flow investment was a small two-bedroom, one-bath house in Portland, Oregon, in 1989. My monthly cash flow averaged a massive $50 per month. Not a lot, but it gave me my start. And that first step was, by far, the toughest. I wasn’t sure if I could actually go through with it. I had enormous amounts of fear.
So that $50 was much more than a few dollars in my pocket. It was the first building block towards the cash flow I enjoy today. There comes a point in your investing life where the cash flow from your investments supports, not only your living expenses, but also your next investments. Your cash flow breeds new assets which, in turn, breed more cash flow.
Here’s the key. To pave the way to your financial heaven, you’ve got to understand these two things:
1. You must know if an investment will give you cash flow, capital gains, a hedge, or any combination of the three.
A stock can give you cash flow in the form of a dividend. If the stock price goes up and you sell it for a profit, then you will have capital gains.
You may hold 100 ounces of silver as a hedge against the falling dollar. If at some point you sell the silver, then any profit will be capital gains.
Robert and I bought 10 apartments in a 300-unit apartment building that was being converted into condominiums. Those 10 units gave us cash flow because the developer rented them from us to use as models for prospective buyers to walk through. Once the project was completed, we sold the 10 units which produced capital gains. We immediately reinvested the capital-gains profit into a cash-flowing apartment building that we still own today. In this one deal, we went from cash flow to capital gains to cash flow. The key was that, even before we sold the 10 model units, we already knew where that money would be invested next.
Remember, if you don’t know where to put your money before you get it, your money will be gone.
2. You must decide which result you want from your investments—cash flow, capital gains, or a hedge.
What’s your plan? What’s your goal? What do you want?
When I began having my money work for me, my goal was this: To acquire two rental units per year for 10 years. At the end of 10 years, I would have 20 units, all cash-flowing. The beauty