Capital Gains vs. Cash Flow Investing
How to Think Rich
Capital gains and cash flow are the two types income you can receive from an investment. Once you understand the difference between earned income and passive income, a good investor will always consider an investment for it's cash flow first and for capital gains second.
Capital Gains
When you buy something low with the intention of selling for a higher price and making the profit you are investing for capital. This is a selling strategy. You must sell your asset to realize a profit.
The income you receive from this type of investment is received in a large sum, usually all at once. In order to keep pursuing this strategy you will have to acquire another asset to eventually sell.
Steve buys a car for $1500 from a family member. He sells the car to his roommate Matt for $2000. His profit is $500. His ROI is %33.33. Steve no longer retains ownership to the vehicle. If Steve wants to continue producing income he will need to purchase another vehicle and find another buyer.
Cash Flow
When you invest for cash flow you are investing into an asset that will give you a small return on your investment from time to time as long you own the investment. Cash flow is a holding strategy, and income from cash flow investing is usually passive income.
While income from cash flow investing may be in smaller payments, it is received on a regular and consistent basis. The income does not come from selling the asset, so you get to keep the asset while you profit. Over time the total ROI one receives from a cash flow investment strategy has the potential to be far greater than any income one may receive from the same (or larger) investment using a capital gains strategy.
Mike buys an SBI website for $300.00. He spends several months developing the content and traffic, ads some Google AdSense ads, and begins to make between $200.00 and $300.00 every month from the site. Two years later, Mike has done no additional work to the site, yet has made over $4000.00 (and counting). There is no need to sell the asset, and each day the website produces a little bit of passive income.
To date, the return on Mike's investment has been over %1100. Since the website produces additional income for every month mike owns it, the true ROI for this investment is infinite.
Cash Flow vs. Capitol Gains
Example Mike 1 (Capitol Gains)
Mike buys a pre-foreclosed house for $40,000. He remodels the house for $10,000 and sell the house for $100,000. His profit is $50,000 his ROI is (100%). He has doubled his money. To many people this sounds like the deal of a lifetime but lets take a look at the same investment through the eyes of a cash flow investor.
- 1 year ROI = $50,000
- 5 year ROI = $50,000
- 10 year ROI = $50,000
- Total ROI = 50,000 (100% ROI)
In this example Mike's ROI does not increase from year to year because the house has been sold already.
Example Mike 2 (Cash Flow)
Mike buys a pre-foreclosed house 40,000. He remodels the house for $10,000 and leases the house for $5,000 down (non-refundable) and a monthly payment of $1000.00.Mike will continue to collect money on this investment forever, or until he decides to switch his investment strategy to capital gains (and sell the property).
In 4 years Mike will have a good portion of the property paid for (by his tenants).Mike will also have equity in the property that he did not directly have to pay for.Mike will also have a positive cash flow of 1000 per month (minus property taxes and maintenance).
If the area where the property was located appreciated over the years mike can now go back to the bank and get his property reappraised and get an additional equity loan for the difference between his old loan balance and the new appraised value of the home. One final benefit of this strategy is that loans do not have to be claimed as income on your taxes (always consult your certified financial advisor).
- 1 year ROI = $17,000 (apx 34% ROI)
- 5 year ROI = $85,000 (apx 61% ROI)
- 10 year ROI=$170,000 (over 310% ROI)
- Total = $$$$$$$ infinite (until property is sold)
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