Whether you are a fake retiree, a traditional retiree living off Social Security, or someone with a day job, cash flow is more important than net worth, especially during an economic downturn.
Net worth is often an illusion that only helps to boost your ego when times are good. When times are bad, calculating your net worth loses it's appeal because it mostly hurts your ego.
During an economic downturn, if you don't invest in cash-flowing assets, your portfolio will likely underperform. If your investments also have weak balance sheets, then they will likely underperform even further.
The starkest performance difference during a bear market is between growth stocks and dividend stocks. Therefore, if you are a growth investor, it's important to take some profits when times are good to capture the outperformance. Otherwise, growth investors won't ever be able to capitalize on their investments since they receive no dividends.
Why Cash Flow Is More Important Than Net Worth
The value of an investment is based off its present and future cash flow. Never forget this truth. Eventually, an investment needs to generate income for its owners, otherwise, the investment is only based on the greater fool theory.
As an individual, your cash flow is what enables you to do what you want. Cash flow is real whereas net worth is subjective.
Do you include the value of your primary residence in your net worth (of course)? Should you calculate your net worth on a pre-tax or post-tax basis (do both)? What should the value of your private business be in your net worth (best to be conservative)? And so many more considerations for calculating one's net worth.
A subjective net worth is why it's unfair to tax unrealized capital gains. Your investments might be worth X one day and X minus 70% several months later. The market is fickle.
Sure, if you accumulated a large enough net worth that produces zero income, you could simply draw down principal to fund your lifestyle. Many do. However, this path is riskier and less reliable.
Because if your net worth produces no income, then it most likely consists of more volatile assets. The main exception are precious metals, and perhaps to a lesser extent, fine art, and collectibles.
My Favorite Free Cash Flow Investments
I love real estate and blogging the most because they are two assets that produce strong cash flow. While valuation multiples expand and contract, I'm busy focusing on free cash flow and creation to pay for the lifestyle I want.
Real estate is my favorite cash flow investment partly due to the steadiness of its rental income. Everybody needs a place to live during good times and bad times. And by the time leases are over, bear markets are usually over as well.
Not only is real estate income relatively steady, you can remodel your rental property to generate more cash flow as well. The ability to take action to improve rental income is very attractive for able-bodied people.
Since I would never sell a strong cash-flow business, its fluctuating value is background noise that doesn’t matter. What somebody is willing to pay for something is both uncontrollable and subjective.
Blogging is a high-margin business because it doesn't cost much to run. So long as you can keep on writing, you will keep on generating cash flow.
Yes, it's sometimes fun to fantasize about being able to sell Financial Samurai for big bucks and finally buy my beach front mansion that will eventually fall into the sea. However, what a shame to give up something fun to operate that's been a part of me since 2009.
Other Attractive Cash Flow Investments
My third favorite free cash flow investment is large-cap, dividend-yielding stocks with strong balance sheets.
The “dividend aristocrats” are 65 companies in the S&P 500 that have paid dividends for at least 25 consecutive years and have raised dividends for a minimum of 25 straight years. You can easily buy a dividend aristocrat ETF like NOBL to capture their dividend income.
The great thing about investing in dividend stocks is its 100% passive nature. There's nothing you need to do except properly allocate your capital.
The downsides to investing in dividend stocks are the inability of the investor to take positive action, being at the mercy of company management and exogenous variables, and more volatility and lower yields than real estate. NOBL, for example, only has a dividend yield of about 1.9%.
Finally, I'm a growing fan of investing in private real estate funds that generate higher yields in a 100% passive manner. Investing in private funds is also less stressful because there aren't daily market value updates. Public REITs, on the other hand, are often as volatile as stocks. With private real estate, you're investing over a 5+-period time horizon.
The older I've gotten, the more I prefer investing in 100% passive real estate investments. Fundrise is my favorite real estate investing platform as it has diversified funds that invest in Heartland real estate. The trend towards moving to lower-cost areas of the country will continue for decades thanks to technology.
Net Worth Is More Of A Momentum Measuring Stick
Since writing the post, The First Million Might Be The Easiest over a decade ago, I haven't talked much about my net worth. The main reason is that after writing about a $3 million net worth, it drew too much negative energy. This conflicted with my optimistic nature.
However, at the time I felt it was important to share my net worth figure to give readers an idea of how much it may take to generate $80,000 a year in passive income. Numbers are vital when writing about finance. Otherwise, it feels too much like fluff.
What matters way more than my net worth is your net worth. After all, my goal is to help you build more wealth.
The most useful reason for measuring net worth may be to give you a sense of momentum. The greater your net worth, usually, the greater your passive income. If not, at least with a greater net worth, you have a greater ability to generate more passive income depending on how your net worth is structured.
Momentum helps keep you motivated. It's very easy to fall off the financial independence journey by splurging on things you don't need with expensive debt. The importance of motivation is why I proposed for beginners or late starters to first try reaching $300,000 in investments. Once you get to $300,000, you'll start getting that financial independence feeling.
And once you get that special feeling of freedom, you won't want to stop!
Reaching $300,000 is much more digestible for people first starting out than reaching $3 million. Once you get to $300,000, reaching $500,000, $1 million, $2 million, and so forth no longer look as daunting.
The Biggest Benefit Of A Large Net Worth
The larger your net worth, the more confident you will feel about your finances. However, just like how tech stocks can lose a tremendous amount of their value overnight, it's dangerous to be overly confident about your estimated net worth figure.
The biggest benefit of a large net worth is having more options to create more passive income if you want. The desire to create more passive income will depend on your age, energy, and desires.
As someone who doesn't want to commit to a 40+-hour work schedule while my kids are still young, I've structured my net worth predominantly towards cash-flow-generating investments. I don't want to risk too much due to a strong fear of losing time.
As a result, here is my net worth breakdown, excluding my online assets.
- 50% of my net worth is in real estate (includes my primary)
- 20% in dividend-paying stocks
- 10% in municipal bonds
- 3% in venture debt
In other words, about 70% of my net worth is in investments that generate cash flow. 30% of my net worth is dead capital that generates no income. These investments mostly consist of my primary residence, individual tech stocks, and private equity / venture capital.
The stronger your cash flow, the less you will need to invest in cash-flow-generating assets and vice versa. Since leaving my day job in 2012 I've been conditioned to invest in cash flow assets out of necessity.
With the growth of Financial Samurai, I've been able to take more risk. However, I'm still predominantly focused on turning as much active income into passive income as possible. Because eventually, I know the good times online will come to an end.
Consistently turning funny money into real assets is one of the best ways to get rich. Funny money conversion is one of the reasons why people who receive huge stock windfalls buy mansions and fine art. At least they know their mansions and Picassos will be around long after their companies go bust.
Ways To Boost Cash Flow
Here are some ways to boost cash flow. Feel free to share more ideas.
- Allocate more capital toward higher-yielding investments. Treasury bonds yielding over 5% is one example.
- Boost work output and efficiency to get paid more at your existing employer
- Job hop to a competitor for an immediate pay raise
- Take a second full time job if you work from home (may not be allowed)
- Increase rents closer to market levels if you haven't done so in a while
- Expand a property to generate more rental income
- Invest in multi-family properties
- Take advantage of higher inflation by investing in I Bonds
- Invest in municipal bonds, treasury bonds, and corporate bonds given rates are higher
- Start a side hustle
- Create a new electronic product or physical product
- Consult or give private lessons based on your expertise
- Be a hard money lender
A high interest rate environment is a positive for those who want to generate more cash flow. Focus on being a saver, investor, and lender, not a spender in a high interest rate environment.
Focus On Your Cash Flow
During times of great uncertainty, it is your cash flow that will enable you to keep living the way you want. Cash flow is what's going to feed your family. Net worth, on the other hand, has no utility. The market is fickle. Try not to pay it too much attention.
So long as you have a proper net worth allocation that matches your risk tolerance, you'll be fine in the long run. Cash flow is what will keep your lifestyle steady during the short run.
Net worth is secondary to cash flow. It's fun to keep track during good times. It'll make you feel better about your progress. You can unwisely brag about your net worth to others. But during bad times, you'll realize that net worth is really of secondary importance.
Eventually, the bear market will end and investors will assign greater values to most risk assets. When that time comes, you'll feel better and you might consider selling again. Or, you might want to hold onto your cash-flowing investments forever. Triggering capital gains tax is such a waste. The choice is yours!
Reader Questions And Suggestions
Readers, do you think cash flow is more important than net worth? Is net worth more of a vanity metric? If you think net worth is more important, please share why!
For greater cash flow, invest in real estate. Real estate rides the inflation wave through capital appreciation and rent growth. Check outFundrise, my favorite private real estate platform that invests in residential and industrial properties mainly in the Sunbelt.
I've invested $950,000 in private real estate to diversify, earn more passive income, and take advantage of the long-term demographic trend.
Invest In Private Growth Companies
In addition, one of the most interesting funds I'm allocating new capital toward is theInnovation Fund. The Innovation fund invests in:
- Artificial Intelligence & MachineLearning
- Modern DataInfrastructure
- Development Operations(DevOps)
- Financial Technology(FinTech)
- Real Estate & Property Technology(PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $200,000+ minimum.
Here's my discussion with Ben Miller, Founder and CEO of Fundrise about AI, private growth companies, and its Innovation Fund.
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