Capital gains is betting that the price will go up while cash flow can often be determined before an investment is made.
What is the difference between capital gains and cash flow?
There are two primary strategies that investors will target for making money! Both are equally valid however one tends to be more reliable than the other. We need to know the differences between them before deciding which is a better option for our needs.
Investing for capital gains is making the decision to not make any profit until the asset is sold. This means that an asset is purchased for a lower price and then sold for a higher price. There are advantages to this however it does have some limitations as well.
Basing a strategy on cash flow means focusing on the fact that the asset produces a regular income. Determining an assets cash flow is something that can be done before an investment is made. Investors that target cash flow as their primary strategy will often know years in advance what their profits will be.
Knowing the difference between these two strategies means we can now look at ways to build a strategy around them.
Investing for Capital Gains
Buy low, sell high that’s the motto for a lot of investors and there are some definite benefits to this. There is something extremely satisfying about having a surplus of cash available when an asset is sold.
There are however several things to consider when choosing capital gains as the primary investment strategy. The first thing to consider is the type of asset to purchase. The fact is that investing for capital gains is speculative by nature. What this means is that there is no guarantee that the asset will grow in value.
To make a capital gain in the stock market requires the value of each individual share to increase. This is not something that any single investor has control over. The reason for this is they’re not inside the deal and have no control over the circumstances. There are also strict laws in place that are meant to prevent insider trading.
If you use technical analysis to buy and sell shares then this is not technically investing, it is actually trading. It does however require a lot of knowledge and skill to successfully make a profit.
Capital gains on buying and building a business is a long term target. This is because it requires effort and skill to increase the value of a business. Depending on the type of business this can also require a heavy amount of capital investment as well.
Investing in real estate has potential for generating capital gains. Choosing the right property and making strategic improvements targeted to the right market has proven to be lucrative for some. Flipping is the term that refers to buying a property doing some strategic renovations and selling it for a profit. This does however require capital both to purchase and to renovate the property.
Investing for Cash Flow
Investing for cash flow is a strategy that involves selecting assets that will generate an income stream immediately. Unlike capital gains the cash flow of an investment can often be predicted with certainty before an investment is made.
Choosing stocks that pay regular dividends is one method of generating cash flow. In Australia publicly traded company’s generally pay their dividends quarterly. While in other markets in may be possible to find stocks that pay dividends more regularly.
Cash flow is the life blood of any business. A business is simply a set of legal and economic machinery that exists for the purposes of generating profits. If a business does not generate a profit, then eventually it will become insolvent and then collapse.
Real Estate can be a speculative venture when investing for capital gains as we discussed earlier. However, when a deal is structured correctly the cash flow of a property can be known before any commitments are made. Income in the form of rental or lease agreements, as well as tax incentives like depreciation, or general business operating deductions.
The vast majority of governments around the world offer incentives for providing property that contributes to economic growth. This growth can be in the form of providing housing for rent, commercial and industrial space for business and agricultural land for farming. There are a variety of opportunities for real estate investors to generate cash flow. The key is to know how to take advantage of them.
Which strategy is better?
Deciding which of these two strategies is better comes down to the personal choice of the investor. It is important to know how to make each work in order to maximise the return on investment. Taxes are levied on profits regardless of whether you are a business or an individual.
When it comes to taxes, how much you pay will depend on a number of things. In Australia for example capital gains is not taxed as a seperate tax but rather as a part of income tax. If for example an individual buys and sells a house and makes a capital gain of $50,000 then that is added to their income tax. If they made $150,000 at their job for that financial year then they would be taxed according to a $200,000 income. This would put them in the highest marginal tax bracket.
Large capital gains can cause dramatic spikes in yearly income that will increase personal taxes. Capital gains can also never be realised if the asset is never sold.
Investing with a primary focus on cash flow will likely result in a lower value yet more regular income. If the cash flow from an investment is positive then this will contribute to gross income. It also becomes possible to use this small increase in income to buy more investments.
This is a time tested strategy used by successful investors all over the world. Focusing on capital gains is speculative and will not always guarantee a return. However, studying an investment and making a buy decision based on the assets ability to produce a net profit will continually increase chances of success.
It is our humble position that investing for cash flow is something that offers far more control and a consistent return if done right. Capital gains can then be a secondary bonus if and when the asset is sold. However there is always an argument to be made for never selling a profit generating asset.
Whatever strategy is chosen it should be done in careful consideration of all of the facts associated with the individual asset and the qualified advice of professional accountants, lawyers and bankers.