Most people who think about investing focus primarily on appreciation — buying something and hoping it goes up in value. This is understandable; dramatic appreciation stories make the news, and the fantasy of having bought Apple stock in 2003 or a house in Austin in 2015 is compelling. But a strategy built primarily on appreciation is a strategy built primarily on hope, and hope is not an investment thesis.
Cash flow investing — building a portfolio around assets that generate consistent, reliable income — is a more controllable, more predictable, and often ultimately more wealth-building approach. Here’s why.
The Appreciation Fallacy
Appreciation is real, but it’s unpredictable and unreliable. Asset prices go up and they go down — sometimes dramatically, and often at the worst possible times. If your financial strategy depends on selling appreciated assets to fund your life, you’re at the mercy of market timing, and market timing is famously impossible to do consistently.
More fundamentally: appreciation doesn’t produce cash flow. A house that has tripled in value since you bought it doesn’t pay your bills unless you sell it. Stock holdings that have appreciated 200% don’t fund your life unless you sell shares. And every time you sell an appreciated asset, you potentially trigger a taxable event and reduce the asset base available to continue compounding.
Why Cash Flow Wins
Cash flow, by contrast, is real, immediate, and doesn’t require you to sell anything. A rental property that generates $800 per month in net cash flow is producing that income regardless of what the property’s market value does. A portfolio of dividend stocks paying 4% annually is distributing income every quarter regardless of share price fluctuations. A business generating $5,000 per month in owner distributions is producing that income as long as the business operates — irrespective of what someone might pay for it in a hypothetical sale.
Cash flow is also more resilient. In down markets, cash-flowing assets still generate income. They may appreciate less, but the income they produce continues — which means you don’t need to sell at depressed prices to fund your life. You simply live on the cash flow while waiting for market conditions to improve.
Building a Cash Flow Portfolio
Start With the Income Target
Reverse-engineer your financial freedom goal. What monthly income would allow you to cover all your expenses and live the life you want? That’s your target. Now: what assets would you need to own to produce that income? At a 6% average yield, you’d need approximately $2 million in assets to produce $10,000 per month. At an 8% average yield, approximately $1.5 million. At a 10% average yield (achievable through optimized rental portfolios and other higher-yield vehicles), approximately $1.2 million. Work backwards from the income target to the asset target.
Diversify Across Income Asset Classes
No single asset class is right for every market environment or every investor situation. A well-constructed cash flow portfolio typically includes a mix of real estate (direct ownership and/or REITs), dividend equities, fixed income instruments, and potentially business income or royalty income. Diversification across these classes smooths out the inevitable performance variations of any single asset type.
The Income Acquisition Playbook
The specific strategies for identifying, evaluating, and acquiring income-producing assets across multiple categories — and for building a portfolio that grows your monthly cash flow progressively toward financial freedom — are in BUYING MORE INCOME by Joshua Crampton.