Welcome to my post about investing for cash flow.
A few years ago, I was looking to buy a rental property when a friend suggested that we go into business together and buy a condo. We looked at a few units and, after running the numbers, I soon realized that what we earned in rent and what it cost us to own the place, meant that we would be operating at a loss of about $200/month. In this case, we would be subsidizing our tenant…which isn’t a great investment strategy! When I mentioned that the property wouldn’t cash flow, my friend’s response was: “all I care about is capital gains.” Needless to say we didn’t buy the unit and went our separate ways.
This story brings into sharp focus 2 different types of investors: one seeking income, and the other seeking capital gains. My investment strategy has always centered on buying income producing assets that will also provide some moderate growth over time. This stems from my view that the biggest financial problem for most people is that they don’t have any money flowing into their pockets beyond their regular paycheck.
To my mind an asset is worth owning, not only if it increases in value, but if it pays the investor an increasing stream of income over time. I don’t like buying something on the mere hope that it will be worth more tomorrow than what I paid for it today…This just seems way too risky for me.
My Favorite Income Generating Assets
In my experience, I’ve found that those seeking additional cash flow have two basic options to choose from: dividend-paying stocks and/or investment properties. Sure there are other choices, such as starting a business or writing e-books, but these require much more work upfront and are not really all that practical for the average person.
Dividend Growth Stocks
A good portion of my monthly passive income comes from owning a portfolio of solid blue-chip dividend paying stocks. Every month I continue to buy more of them with my savings. I also reinvest my dividends automatically to take advantage of compounding. Overall, half of my annualized rate of return comes from the dividends while the other half is capital appreciation. I can sleep at night and ride out volatility on the stock market because I focus on the income that my portfolio generates – and not on its value at any given time. As I’ve said before, as long as my passive dividend income continues to increase, that is the only real “trend” I focus on.
What I like about the dividend growth strategy is that it’s pretty much set on auto-pilot. My savings gets invested through automatic share purchase plans, the dividends are reinvested automatically and **bonus** my companies regularly increase their dividend payout. Essentially, without any active participation on my part, the portfolio will continue to generate an ever increasing amount of cash.
Assets that generate cash on their own are valuable assets indeed. Left unto themselves to compound over time, they can grow into a significant source of retirement income.
Real Estate Investing with Rental Properties
Some people consider the stock market too risky and prefer instead to invest in something tangible like real estate. For these people, investing in real estate can make a lot of financial sense. A big difference however, between investing in stocks and investing in real estate is that RE has a much larger barrier to entry.
Down-payments on investment properties are usually 20% of the purchase price. Add in legal fees, land transfer taxes etc., and the initial cost of acquiring a rental property can easily run into the tens of thousands of dollars, if not more. Owning real estate is also a much more “hands on” type of investment versus owning stocks. Personally, I feel that the risks of owning real estate investments are greater than owning stocks in that, while stocks can go to “zero,” real estate can actually set you back into the negatives.
On the other hand, for those who are capable of effectively managing their real estate investment, owning rental properties can generate a lot of cash flow and create a lot of wealth over time. The key is to make sure that the monthly rent covers all of the expenses associated with the property. These include the mortgage payment, utilities, property taxes, insurance, maintenance etc. Once all expenses are paid, the property should generate a profit which adds to the investor’s monthly cash flow.
A Blended Approach to Investing For Cash Flow
When it comes down to it, a person’s knowledge, experience and risk tolerance will dictate which of the two approaches to income investing to follow. But in my opinion, there’s no need to choose only one approach.
For someone with a small amount of savings, it makes sense to start out with buying a collection of dividend paying stocks because they are far cheaper to acquire than real estate. Over time this stream of income will inevitably grow and if one chooses to keep investing solely in dividend stocks that’s completely fine. There are many people who successfully follow this approach. In fact they choose to invest a portion of their portfolios in real estate investment trusts (REITs) to gain exposure to real estate.
Other income investors, including myself, choose to follow a blended approach where we invest in both, dividend stocks and rental properties. I believe that both asset classes are great long term investments, and both add about $1000-$2000 to my monthly cash flow. Going forward, that monthly income will continue to grow as I hope to build out those investments. That’s my approach to investing for cash flow.
Image credit: Image courtesy of Gualberto107 / FreeDigitalPhotos.net
John K
Wednesday 6th of July 2016
I'm new to income investing, and I have a question I simply can't find an answer to.
Nearly everything I see online shows a typical cash-on-cash return with RE as being a realistic 10%. Meaning I could take 30k, invest it in a property and expect a post-mortgage post-management post-vacancy etc. return of about 3k/annually. At least, that's what BiggerPockets members say, along with turnkey investment companies. They seem to line up.
If this is the case, then why would anyone consider dividend stocks at all? Of course, for the reasons you outlined - the barrier to entry is higher with RE than stocks, as well as less liquidity, etc..
But in your case, since you have the cash available - as is evidenced by your 1,000-2,000 monthly cash flow - why not simply remove your investments in stocks, and use debt to acquire more cash flow positive properties?
GenXinvestor
Monday 11th of July 2016
Great question John. I've been looking at my dividend stocks and saw that the average rate of return over the past 4 years was about 9%. That number includes both, dividends paid out to me and the capital appreciation. My real estate investments return a whole lot more than that...which is why I've been pouring more money into rental units than dividend stocks. In general I think that real estate holds a lot of people back because it requires a lot more financing than, say, dividend stocks which can be bought for as little as $25. Then there is probably the fear factor...the what if it doesn't work out etc. Leverage is great when everything is working out but can crush you if you get over extended. I think that people are naturally risk averse and that includes whether the risk is "real" or simply "perceived." When I told people that I was investing in a rental property they thought I was crazy. Of course I was to them because I don't "invest" the way that they do...in a savings account that pays 1% interest! In the end, I think it's good to have a broad range of income producing investments. I like to be diversified...even if it means that I'm not making as much profit as I potentially could. The stock markets rises and falls on a daily basis and we've seen some really bad real estate crashes over the past 30 years. While the real estate market seems to hold up better than the stock market, there's still no shortage of horror stories about bad tenants wrecking a rental unit etc.