First the Disclaimer: This is a thought-provoking article
that draws upon real world examples, articles, books and
websites that are readily available to the public. This
article is not intended to offer investment advice. Any
actions that you take in the market place should be the
result of your own financial education and consultation
with a licensed professional.
This is the conclusion of my 3 part series that began with
Home Ownership: The Biggest Financial Scam of the
Twentieth Century and was followed up by parts one and two
of The Stock Market: The Second Biggest Financial Scam of
the Twentieth Century.
What is Cashflow? Cashflow simply put is the flow of
money. Positive cashflow is the revenue or income that a
person receives from a job, investment or business. The
majority of people derive their cashflow from their jobs.
To the extent that they come to derive cashflow from
investments and or businesses is the extent to which they
will become financially free when their working years are
over. Negative cashflow is the revenue that a person loses
due to an investment or business.
Most people are taught to invest for capital gains rather
than positive cashflow. Investment success depends on
appreciation of the underlying "asset" rather than income
production. This is the basis for "investing" in a primary
residence or the stock market for wealth creation. Yet,
success of the capital gains investment strategy is by no
means assured. No one can guaranty that an asset will
appreciate in value, despite the tendency to quote
historical gains as justification for an investment today.
The current housing and market crises highlight the fallacy
of depending on capital gains to create wealth. The
housing crisis alone will destroy billions of dollars of
personal wealth. From the October 25, 2007 Joint Economic
Committee report:
The JEC report found that the subprime catastrophe is
likely to accelerate the downward spiral of house prices.
Based on state-level data, the report estimates that by
2009:
• 2 million foreclosures will occur by the time the
riskiest subprime adjustable rate mortgages (ARMs) reset
over the course of this year and next.
• Approximately $71 billion in housing wealth will be
directly destroyed because each foreclosure reduces the
value of a home.
• More than $32 billion dollars in housing wealth will be
indirectly destroyed by the spillover effect of
foreclosures, which reduce the value of neighboring
properties.
• States will lose more than $917 million in property tax
revenue as a result of the destruction of housing wealth
caused by subprime foreclosures.
• The ten states with the greatest number of estimated
foreclosures are California, Florida, Ohio, New York,
Michigan, Texas, Illinois, Arizona and Pennsylvania. But
there are several others that are close behind in the
rankings.
• On top of the losses due to foreclosures, which this
report examines, a 10 percent decline in housing prices
would lead to a $2.3 trillion economic loss.
The power of positive cashflow is that it guarantees the
value of an investment regardless of the markets. Imagine
the difference between a real estate investor who bought a
house expecting it to go up in value versus the investor
who bought for cashflow. The capital gains investor bought
at very high premiums in the market such that the rents
received for his investment do not cover the expenses. Now
the investor must find a buyer who paid more than he did in
order to make a profit. If the market goes down that
investor will find that he has no staying power and will
likely sustain a substantial loss to liquidate the property
and limit his on-going monthly losses. The fate of the
cashflow investor is much more secure. The positive
cashflow yielded by the property will continue regardless
of market activity. Should the market go down, the
cashflow will continue, giving the investor staying power
and continued profits in a down market. More importantly,
most if not all of the positive cashflow will be shielded
from taxes by depreciation expenses on the property. In
short, the cashflow, not the capital gains, on a property
will usually be tax-free. Avoidance of unnecessary taxes
is one of the best wealth acceleration strategies you can
employ. To quote David Swenson from Unconventional
Success, "Taxes impair wealth accumulation."
Cashflow strategies can also be applied to the stock market.
The trouble with cashflow investing is that it requires
having a financial education. Cashflow investing requires
the ongoing thirst for financial knowledge specific to your
chosen area of cashflow generation.
The capital gains strategy encourages financial ignorance.
Tempting the would-be investor to treat their investment as
a money-in-money out proposition. Actively seeking
financial education is the only way that a cashflow
investor will be successful. Yet the odds are against him.
Not because financial education is difficult to attain,
no. The odds are against him because the financial sales
people any would-be investor will encounter are paid
commissions based on their ability to sell products and the
majority of those products are for capital gains rather
than cashflow. I find one or two real estate deals per
year that yield sufficient positive cashflow for me to
consider the deal, yet I am often encouraged by brokers to
ignore my criteria for cashflow and invest instead for
capital gains.
The cashflow strategy requires that you learn to work with
people to form a team and generate profits for all. A
capital gains strategy has people so focused on maximum
gain that they ultimately succumb to greed, fail to exit an
investment at an appropriate time and experience financial
loss.
Even in today's economy cash in the bank is not a source of
solace as savers are seeing their returns destroyed by
interest-rate-cutting policies of the Federal Reserve.
People who depended on interest from savings to provide
retirement income are seeing their incomes dissipate as the
Federal Reserve sacrifices their incomes to bail out Wall
Street, Banks and the derivatives markets.
The actions of the Fed and the behavior of Banks and Wall
Street have proven that it is cashflow, not cash that is
king.
----------------------------------------------------
Ouida Vincent is an active real estate investor and
entrepreneur who has watched her friends and family members
struggle under the burden of home ownership and poor
returns in today's market. To find out more go to
http://www.ouidavincentsblog.blogspot.com
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