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 out Fundrise, 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 the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- 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.
For more nuanced personal finance content, join 65,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.
Hi Sam, any advice on cash flow strategy for those of us investing with Robo advisors, such as Betterment, Wealthfront, SoFi, etc?
My investment approach is set it and forget it via index/ETF with trusted robo advisors as I very much care about my investment performance but I have little appetite for actively managing such investments.
I’ve just “retired” at 55 with a few million allocated as follows:
40% in robo IRA, 60/40 stock/bond.
43% in robo taxable, 80/20 stock/bond.
7% individual stocks, mostly tech/growth.
10% cash in Treasuries w term 1 year or less.
Homeowner in San Diego w no mortgage, currently renovating so we can move into ADU on site while renting out the main house (expecting around $5k per month).
Now that I’ve stopped working, I tap my cash for living expenses and kid’s university and leave all other investments alone, which prompts my question re enabling cash flow via robo investments.
I’d like to figure out if I need to adjust my approach of burning liquid cash for living expenses, esp as time moves on and I deplete those cash reserves.
Hard to know without knowing everything about you and your goals.
Here’s a related post about DCA. https://www.financialsamurai.com/better-investing-figuring-out-how-much-more-to-dollar-cost-average/
And another on asset allocation:
https://www.financialsamurai.com/the-proper-asset-allocation-of-stocks-and-bonds-by-age/
It’s great that you mentioned how your cash flow is what would enable you to do what you want as an individual. I want to learn more about investment, so I’d like to try looking more into it. I heard a bit about immediate cash flow investments before, and it sounded very interesting.
What is your opinion on covered call ETF’s like QYLD, RYLD, and XYLD? These ETF’s yield between 9 – 12% and have monthly dividends. What is the argument against owning these if I never plan to sell and just want to hold them for the income?
Cash flow is it. Finally broke thru the 300K per year without real estate. Had some and sold. Maybe buy more, but with interest rates going up my 300K should turn into 330k per year. I used to have more drive but now have more grey hair. Young folks, save your money ! Great site, by the way
You had a post a few years ago where you said growth stocks over value. Looks like you have changed your philosophy.
Depends on your stage in life. If you don’t have a job, are retired, are older, focus on cash flow.
If you’re in your 20s and 30s still aggressively building your capital, focus on accumulating your capital.
Fair enough. Even in your 40s I feel you need a little of growth – there are a number of stocks that offer both growth and dividend (dividend aristocrats like you mentioned I think are a great example) We are speaking the same language though.
Have you considered the point that you made in the article around REITs being as volatile as other stocks being an indication that non-liquid real estate value is not as stable as most people think, but rather just an illusion of stability created by illiquidity? I know the point of the article was around cash flow rather than valuation but the “stability of real estate value” is something I commonly hear pitched (including I believe on this site) as an attractive point on real estate investing. As soon as RE becomes liquid by making it stock, it’s just as volatile as the stock of non-RE focused corporations, even though REITs manage many properties across different asset classes and / or geographies (which should in theory be more stable than an individual property of the same asset class).
Separately, why would the volatility of REIT values matter if you are in fact focused on cash flows? REITs pay dividends, and the volatility creates opportunities to buy in at higher yields than the average of what it trades at (since more volatility of price means there’s more days that are above and day that are below the average yield)
Yes, there is definitely an illusion of stability for private investments that don’t have daily or hourly market values. And frankly, that’s really comforting during downturns, because you aren’t scared or as distracted and emotional to sell at the Lows. You just go on living your life as normal.
So much about getting rich through investing is battling your emotional demons. We know we need to hold on for the long term. But often, we sell in the short term out of fear.
Sounds like you own some public REITs and are wondering whether to hold on or not?
I think I agree with the overall sentiment in this article. But when it comes to passive investments, atleast, I think it makes more sense to just focus on your overall risk tolerance and to structure your portfolio accordingly with the right combination of asset classes and to ensure that your holdings within each asset class are diversified. The cashflow that comes from those investments is what it is. I have seen some people become obsessed by dividends or bond yields and, therefore, end up chasing after risker bond and/or stocks or funds to get a higher dividend to increase cashflow. Sure, you could invest part of your stock and bond portfolio into high quality funds (like NOBL) that pay a higher dividend… but it wouldn’t be enough to significantly “move the needle” in terms of cash flow that the portoflio would generate. When it comes to more active investments like owning rental properties, running a website, asking for a raise, yeah, those things are great ways to generate more cash flow which makes sense since involve more time to run and manage
“I have seen some people become obsessed by dividends or bond yields and, therefore, end up chasing after risker bond and/or stocks or funds to get a higher dividend to increase cashflow.”
I’ve seen many trainers and educators, whose job is to prepare people to do something, and to cut them from the program if they cannot make satisfactory progress, fall into a similar hole. They ofttimes get too focused on either bringing everyone up to a satisfactory level, or else get too focused on aggressively cutting everyone from the program that doesn’t immediately measure up. Many people have a hard time keeping sight of the overarching goal when wearing two very different hats that appear to be at odds with each other.
So far as being confident in your investment selections goes, I read “One Up On Wall Street” by Peter Lynch (the patron god of investing) when I was considerably younger and one of the anecdotes that still remains quite clear in my memory is this.
He mentioned he was out golfing in Scotland when the Crash of ’87 began. His first instinct was to run for a phone (no internet, no cell phones) and take personal charge of his fund. Then he realized he had chosen his investments to the best of his ability, and he had faith he had done well. He then went on to finish playing his game.
I am thankful that I finished all my major changes to our portfolio just before COVID became a thing, and I haven’t had a reason to change a thing yet.
From this column: “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.”
I generally agree with this statement; however, I suggest that Berkshire Hathaway (class A or B) might be an exception. It pays no cash dividends, rather continuously re-invests earnings into new opportunities. Or, maybe, this re-investment might be considered a cash return as it grows the value of BRK.
This article comes at a great time for me. I’m strongly considering selling one of my rentals. It’s in an ok, but not great neighborhood, and the tenants, even with my very strict fico score standards (700+) always seem to be problems. Mainly maintenance and repair issues, so not always their fault but confrontational seems to be the norm, rather than problem solving. This particular property has darn near tripled in value in the last 5 years while the rent has more than doubled. While I can see property values in my area taking a hit since they’ve gone up so rapidly, I don’t see them tanking completely and I certainly don’t see rent doing anything but going up. So I’m kind of torn between dumping it and taking profits and renovating it for even more income. I work in construction part time since retiring at 56 so I can do nearly all the renovations myself. I owe nothing on it. Our other rental is a short term, and we have no plans to change anything with it for the time being. With the state of our country, it’s hard to determine the best course
Hi Sarge, do you mind sharing more about your tenant issues? I’m just curious. My rental is in an okay (not great) neighborhood and I have fairly high standards (660 FICO, etc.), but my tenants so far have been excellent. Very flexible, chill people who take care of the property. I’ve always thought FICO would be a very good bellwether, along with other screening tools. Just wondering what you’re seeing and if you have any idea as to why your people are troublesome.
Another idea which you may have considered: why not renovate it, bump up rents, sell for top dollar based on cap rate with new rents and 1031 exchange into something else? You could potentially get a better property or a couple of fixers and increase value with your construction experience. Just spitballing here. :)
Sure thing, Yeti,
The metropolitan area I live in doesn’t exactly have any bad neighborhoods- as in anything I’d be afraid to go out at night. But some areas are mildly run down. During the last ten years, those run down areas have really been on the mend for the most part. Really the only houses that aren’t looking too swift are owned by older people having trouble keeping them up. Younger folks tidy them up quickly. Especially since around here they’re grateful to even own a home.
One of my rentals is in such a neighborhood. When it comes up for rent it is often the least expensive 3 bedroom house on the market- and now that I mention it, that may very well be the problem. Potential tenants may not have poor credit but I do tend to draw more problematic people.
Like I said, many of the problems are legitimate maintenance or repair but some are caused by the tenants who them expect me to correct them. Example would be rodent trouble caused by cleanliness issues, dog kibble left laying around, loose cereal laying on shelves, doors left open etc. another would be a tenant who either ran into an AC unit or ran a lawnmower into it causing it to shift creating a leak in the coolant. AC guy telling me that’s what he thinks happened, but me having no way to prove it.
In my other rental in a better neighborhood, the renters generally take great care of the place. In both homes, the usual reason tenants move is because they bought a home. Late rent is almost never an issue. The only time it was was when I had first become a landlord, and I took a chance on a felon with poor credit. Nice guy with a nice family, great job as an engineer but couldn’t pay rent on time to save his life. He did pay but in 2,3,4,5 installments over the month which was a complete headache.
But yeah, you might be onto something. Maybe I should renovate it. If I did it myself, I could make that place gleam for under ten grand.
Throughout history, wealth was thought about in terms of how much income it could produce not as in how much of it one had.
Think rents, crops, livestock and orchards.
Selling acreage, seed or breeding stock was widely regarded as unwise if done during good times and a sure sign of desperation during bad. In both cases it permanently impaired potential income.
Selling shares reduces the future ability to keep selling shares. This is true even in an up market if the portfolio return is lower than the required withdrawal rate and is magnified in flat or falling markets.
“The lower the interest rates go, the higher the asset prices can be and they have substituted capital gains over the last couple decades for cash payments. When money is easy people behave badly.” The Revenge of Risk Rates & the Return of Dividend Investing
I agree with everything with one caveat: the older I get, the more I appreciate owning and managing physical real estate investments. I just had a turnover in one of my units and it is a great opportunity to involve my oldest (10yo) in some physical labor like cleaning out junk, etc. He gets to work on a big yard clean up next week and I’ve drug him to several showings with me over the years. I also don’t find it very difficult to self-manage a couple investment properties, work a fulltime job and parent. You just learn to be a master delegator and have strong organizational skills.
Sam,
With Fundrise, did you invest in growth and then switch to the income focused funds. Or did you put majority/all of the initial funds into income.
I am increasing my Fundrise (RE) allocation per your suggestion and trying to decide which funds to target.
Do you remove outstanding mortgage balance from your net worth accounting? Lets say your house worth 3 mio $, outstanding mortgage is 2 mio $, do you say your net worth is 1 mio $?
Yes. And probably a 6% – 20% discount to account for selling costs and taxes if you don’t do a 1031 exchange.
Is “mio” a new way to write million? Never seen that before.
I partially agree. Investments that pay out distributions are probably safer. The downside of cashflow is you have to pay tax on it. So for someone with a job or business generating income it might make sense to have long-term investments that minimize distributions. Also, I have retirement investments that look just like regular mutual funds but they don’t pay distributions while you are in saving mode – for example with TIAA-CREF. So no cash flow but very similar to another investment you could make that pays out distributions continuously. I mainly like Australian companies that pay dividends for the tax credits they generate for Australian tax payers.
Yes, if your active income is high, your marginal tax rate will be high and the investment income won’t be necessary. So the idea would be to own non income-producing investments. However, that is also riskier given non income-producing investments tend to be more risky as investors are investing for unknown future cash flows.
But definitely taxes are a consideration. And having rental income that can be shielded from depreciation is always nice.
I got a little different take than you on this issue. If you have a large enough net worth cash flow is almost irrelevant. If you need money sell some assets. If your net worth is large enough it doesn’t matter whether you sell your assets at the high or low. Either way you still have enough. A large net worth also makes it far easier to whether bear markets in all asset classes. It also gives you the flexibility to buy when others are selling which leads to even a higher net worth.
You are correct net worth is a bit of a vanity issue. It’s also a way of keeping score. Until Forbes starts publishing the top 100 highest cash flow people on the planet it will probably stay that way.
Yes, if you have a huge net worth, cash flow is less relevant. Maybe after a $30 million net worth.
But I’m referring to 99%+ of the population looking to navigate these current times.
That is not sustainable though, eventually you’ll need cashflow that isn’t dependent on having to sell the underline asset. Also, you’ll notice that in your own example you mentioned a wealthy person selling some assets to generate cash which is “cashflow” so even in your own example the wealthy person still needs cash flow they just go about generating it by selling assets.
That’s all true, but if you have a large enough net worth you just eat into principle. Also if your net worth is large enough you know those people already have some income producing assets. If not they probably have a lot of cash that they can use.
I’m not debating the importance of cash flow. I’m just saying if you have a large enough net worth maximizing cash flow isn’t necessarily the priority.
A large enough net worth and you just borrow on margin to fund consumption to allow your heirs to get the step-up in basis on the underlying assets at your death.
OTOH, we’re restricting cash flow as much as possible so we can finish converting our tax-deferred accounts to Roth up to the top of the 12% (MFJ) bracket.
We should be done with the above by the time we’re both 60, so all that sweet Roth money will come out tax-free for ourselves and our heirs.
Cash flow is king, and there are actually 2 sides to that equation. Income as you said, and expense. It’s easy to ignore expense as a necessary evil, but you can get creative and lower your cash outflows with minimal work. As we approach 3 years of 8+% inflation this becomes more and more important.
Last year we installed solar panels. It is about as passive income as it comes. It offsets our electric bill in its entirety (which used to be paid for with after tax dollars). It also generates an additional $100 a month or so.
Another benefit is that we recently received a notice from our utility saying that rates are going to have to increase. Instead of this being negative news, it was actually a positive message telling me my income is going to increase.
Also get a bidet, you’ll save a fortune on toilet paper :)
Yes, for sure on Toto washlets. Have three of them in my house and will never go back.
Good thinking on solar panels as a passive income source. But was was the upfront cost? My neighbor just did Tesla solar panels and I think it cost him $21,000. Some permitting and installation PITA issues too.
Didn’t realize Tesla was selling hardware outright now, their (solar city) model was long term lease your roof, no upfront cost since solarcity owned the hardware and the homeowner paid solar city. Its was a front loaded capital intensive financing play for them as I understood it. Nice to see that changed…
CK and Sam, did these installs include battery storage? CK, sounds like you’re selling power back, not available in many areas (PGE closed that option some years back did they not? Not they will ‘accept’ excess homeowner power, not ‘buy’). I’d consider battery and go off grid…
Very interesting and informative post as always, Sam, thank you!
Your net worth allocation indeed seems a departure from that of other higher net worth households. Take a look at this distribution from the Fed Survey of Consumer Finances.
(The reason I find this data point useful is that it truly represents a national level government survey and is relatively robust)
As net worth increases, asset allocation to “Business Interests” goes dramatically higher. This could be one’s own business (e.g., your website, books, etc. which I know you’ve excluded), but also private equity, venture capital etc. (which you’ve not excluded). At the $10MM net worth mark, ~40% of net worth is in such “Business Interests”, while yours seems dramatically lower given your cash flow emphasis. Of course, these Business Interests are much higher risk, but the large point that the chart makes is that as net worth increases, the appetite for risk tolerance also increases and higher net worth households dramatically increase their investments in such riskier assets with high-growth potential.
Your post is very thoughtful, and you’re certainly not advocating a “one size fits all” approach, so please take the below as a discussion point.
As you pointed out, the “the biggest benefit of a large net worth is having more options to create more passive income if you want”.
Is there a chance you have under-optimized your portfolio even in the pursuit of passive income? For example, the Muni Bonds and Dividend Stocks (30% of your net worth) have <5% return rate. After you hit a "minimum" level of annual passive income ($200K?) wouldn't it have been more optimal to increase your exposure to riskier assets (private equity, venture debt, or even growth focused funds in real estate crowdfunding)? Yes, they are more volatile, but over the long run (10+ years), that volatility would not matter, and your annual returns would be meaningfully greater than 5%. You would be expected to periodically "rebalance" as you can (e.g., if private equity as a huge run up, you could take some profits off and put in passive income/lower risk funds).
By the time you're in your 60's, your overall net worth *and also* your passive income portfolio would be higher with this kind of increased risk tolerance approach, isn't it? Certainly many higher net worth households seem to think so.
I think what happens is that the more satisfied you are with your net worth, the less you care about optimizing it. Again, because net worth doesn’t matter to the extent that you have enough passive income to do what you want.
I’d much rather have 100% of my desired living expenses covered with great certainty and miss upside than taking too much risk and not being able to live the way I want. Got to eventually be satisfied with what you have.
How about you? What’s your situation? What percentage of your net worth is your business?
I don’t have a business, but I have a paycheck from a job.
Conceptually, the paycheck is similar in some ways to your passive income target (it well covers our living expenses, and generates savings we can then re-invest; albeit it is likely taxed at a higher rate as wage income than true passive income which would have a lower investment tax rate)…so in theory, I can take higher risks with my re-invested savings since my “passive income” target is already met.
Yet, in other ways, it is not similar. In a major recession, I could outright lose my job, and hence, lose that paycheck entirely (while your passive income portfolio would probably not be impacted as much)… so this steers me to build a passive income (i.e., low risk) portfolio out of my savings to at least mitigate the risk of job loss.
So two contradictory directions I’m trying to think through.
Time for you to follow your beliefs and start a business then!
“ Conceptually, the paycheck is similar in some ways to your passive income target (it well covers our living expenses, and generates savings we can then re-invest; albeit it is likely taxed at a higher rate as wage income than true passive income which would have a lower investment tax rate)…so in theory, I can take higher risks with my re-invested savings since my “passive income” target is already met.”
Don’t think this makes sense. Your job is active income. You need to work to make the money. But if you have a spouse, you having a job enables your partner to take more risks if you continue.
With uncertainty cash flow is better. I wish I sold off some of my tech stocks months ago and locked in those gains. I’ll probably have to wait years until they are up to fall 2021 levels.
For growth investors is it worth buying growth stocks at lower prices these days or dividend stocks?
I’m buying the S&P 500 and some growth stocks here. I can’t help myself. Been doing so for 25+ years now.
Sam – Could you tell us a little more about your 25 year formula for allocating to an S&P fund vs growth stocks during a bear market? I’m very interested in any formula that has served you well over that long of a period! Also, do you mind sharing which growth stocks you are currently evaluating at these levels? Any buying strategy that you have employed for 25 years, I would love to know a little more about. Also, interested because I have personally been all in on pre-tax investing with very little in after tax. It has been hard to find a starting point to get in the market with after tax dollars with everything so elevated during the bull market. However, now seems like the perfect opportunity to start building an after tax portfolio.
Here are some relevant articles. Hard to generate passive income if you don’t beef up your taxable counts.
https://www.financialsamurai.com/better-investing-figuring-out-how-much-more-to-dollar-cost-average/
https://www.financialsamurai.com/after-tax-investment-amounts-by-age-to-retire-early/
Please also pick up a hard copy of my book with charts as it will answer your question and provide you a game plan.
It is important not to wing it when it comes to your finances. My book will act as a financial coach along your financial journey.
Good stuff! Thanks, Sam!
Not addressed in this article but this is why there is a statement of cash flows for public companies. You had some getting clean opinions and were profitable for accounting purposes but had no cash flow. Cash is indeed always clean.
Hi Sam, I have been reading for a couple years now and love what you put out. It has helped me tremendously since graduating college and having a professional job since June 2019. I do have a question about private RE specifically fundrise and crowdstreet and hoped you could clarify or even write a post about the rules related to investing. I own 3 rental properties and my primary residence and am finding I want to get more into the passive nature of those platforms rather that growing my active rental portfolio. There is a condition that you can only invest 10% of annual gross income or 10% of net worth. I have read a couple of your posts stating how you sold a rental property and reinvested a large portion of the proceeds into private RE. I am just wondering if I am missing something related to how you did that because you are very open about having the goal of ~$300,000 in passive income and the amount invested was much more than that.
Thanks again for always being so transparent and all the information you provide. I look forward to reading your book!
“There is a condition that you can only invest 10% of annual gross income or 10% of net worth.” Can you clarify on this? Whose rule is this? And what rule is this exactly?
Are you talking about my recommendation of limiting 10% – 20% of total investments or net worth toward alternative investments or in real estate platforms? Thanks
I have read your recommendations for allocating to alternative investments but that is not what I am talking about. When you add funds in fundrise before confirming your investment the second acknowledgement states “I represent that my investment(s) in this offering(s) does not constitute the greater of 10% of my gross annual income or net worth, either individually or in the aggregate.”
Ah yes. That is their guideline. And a good guideline at that to encourage investors to be more thoughtful about their asset allocation. You don’t have to be an accredited investor to invest in Fundrise’s funds. So Fundrise doesn’t want those with under less than a $1 million net worth excluding their primary, or less than $250,000 in individual income to improperly asset allocate.
However, what I have discovered is that investors can do what they want more often than not. But discipline and a property asset allocation is key.
Thomas S, help me understand. You graduated college in 2019 and started working professionally. You now own 3 rentals and a primary. Let’s say you graduate and walk in June, that exactly 3 years. How did you purchase 4 properties in 3 years by age ~24?
They probably state that so that they can say later they warned people not to invest too much if things go wrong people won’t be able to sue them on that basis. But it does make sense to limit how much you invest with a single fund manager in case things do go wrong.
Cash flow makes a world of difference in so many things. As my income increased during my career, I did my best to limit lifestyle inflation. Even though I had more cash flow, I didn’t want my expenses to skyrocket. So I tried to increase my investment contributions while maintaining my expenses.
I know it’s a very niche market, but I am always surprised working interest and royalty interest in energy projects aren’t ever discussed here. Successful projects produce monthly cash flow and the tax incentives just can’t be beat between IDC and depletion. I would never recommend anyone invest in a crowd funded type energy investment similar to the real estate stuff y’all post on here. These all produce lower ROI then direct participation and good deals don’t need crowd funding in any industry as they will be purchased by industry participants and even in tough markets there are plenty of funds with capital shopping for and backing the top tier management teams. Then you have the whole world of family offices shopping assets. I know people seem to be happy using crowd funding platforms, but let’s see over the medium and long term ( 5-10 year window) how these perform in all industries.
Happy to entertain a guest post from you on royalty interest in energy projects! I’ve never invested in them, so I have no idea.
Please share the how, why, historical returns, and potential future returns. thx
I did a PE Renewable Energy deal. It was my first in the energy sector. Won’t see any return for a few years as it is built out. So its a TBD for me.
I brought this up many times on the blog. Especially when the post discuss primary residence as an asset gaining value. Sure it is but the only ways to tap that value are to sell your house or take a line of credit against the equity. Same goes for growth stocks and investments that produce no cash flow. In this higher interest rate environment we will see or the next few years even real estate producing a 6% cap rate will be insufficient as the risk free rate continues to rise the rate of return on risky assets either has to go up or the asset value has to go down. This will be more a concern in 6 months or so as the fed continues to raise rates driving the risk free rate of return up.
You’re only long real estate if you own more than one property.
There’s no doubt those who want to get to FI need to position their investments for cash flow. Once you quit your active job, cash flow from your passive investments is King. Once I quit my day time active job, I had 3 buckets for cash flow. Business, rental properties, and dividend income.
Awesome content as always. I struggle at times finding the right path in my financial journey. I am a new physician (5 years removed from residency with new job making $275k) with a young family. Thanks to your advice i have maxed out my 401k and my wifes as well, funded my children’s 529 plans and maxed out my roth ohio 457 as well.
I have set aside more than enough for emergency fund (50k in checking account, i know dont crucify me) and now struggle to find ways to make smart choices with excess cash flow. I have 10k in I bonds (again thanks to you) and 50k in growth stocks/ETFs on Robinhood. As someone just starting their path to financial freedom (currently 34 years old) what steps would you take at this age knowing (God willing) that you have time in the market
Ive read previous posts referencing at my age I should have 90% in stocks. I just struggle to continue to be so heavily attached to the stock market given I am contributing 80k a year in my retirement funds. Any help/advice would be greatly appreciated!!!
Sounds like you’re doing great. As a young doc, I would recommend you save and invest at least 30% of your gross income. Eventually, get it up to 50%. At this rate, you could become FI in your 40’s. Have 6-8 months emergency fund. Also, I would recommend going 100% equities at this stage, not 90%. You should be extremely aggressive, because you’re investing for 15-20 years.
Thank you for the tip ! Very much appreciated
Investing can often feeling daunting in the beginning. But once it becomes habit, it won’t. And it’s important to think in percentages not absolute dollar amounts to overcome your fear.
You will most likely earn a lot more money over your career. GL and I discuss so many of these concerns and fears in Buy This, Not That. I’ve got solid frameworks for you to follow over time.
Sam, you have the best content on the web. I bought a hard copy of your book. We all should buy a hard copy of your book to help support you. Your content is unique and valuable, and I appreciate your time commitment and the duty of care you extend to your readers. I’m a security professional, and I had been in some nasty situations. I really meet anyone who weighs risks and threats properly in their lives. Including their investments. I try to stay optimistic, as there’s no upside to being pessimistic. Though I’m always looking at risks and threats, even in my investments. This is one of the reasons I use the permanent portfolio and the Goldenbutterfly. I’m now giving a serious look at NOBL. Cashflow is KING and the Paranoid survives.
What if one has a high paying job, already in 37% tax bracket plus state taxes. Any cash flow will be earned income, thus max tax. Would it make sense to minimize cash flow and build equity? Keep leveraging real estate, dividends are reinvested, would that be smarter? Please anyone feel free to respond. Nice
If you’re in the 37% tax bracket, qualified dividends will be taxed at 20% (plus an additional 3.8% Obamacare surcharge). Still, that’s less than 37%!
Taxes must be paid on reinvested dividends. (You reinvest the full amount but at tax time you’ll report the dividend as income.)
Actually, qualified dividends are taxed as long term gains, not income.
cash flow earned on rental income is not taxed since there is a non-cash expense called property depreciation. Rental properties are the best investment class for folks in higher tax bracket. Roughly ~90% of my net worth is currently in this asset class
I have always been puzzled by this claim. How much of property depreciation must one claim in order to pay zero income tax on you rental income?
It’s a fairly straight-forward calculation (sort of!). Determine the depreciable portion of the investment (buildings,etc) and divide it by it’s expected years of life, to determine the depreciation per year. There are some special categories of assets that offer accelerated depreciation as well. Then, ordinary income is reduced by this depreciation, defering the taxes until the asset is sold. At sale time, one would have a recapture of all the depreciation, but the beauty is it’s taxed at long-term capital gains rates rather than ordinary income.
Mostly true, Bob. It’s taxed at long term cap gains except that the depreciation you took is recaptured at 25%, and having all that income hit in one year can cause some extra-fun surprises, like pushing you into AMT and the Net Investment Income tax. It’s a little better than paying ordinary income taxes, but if you’re not in the highest tax bracket when you’re taking the depreciation, you could actually be a little better off taking less depreciation and having less capital gain at the end of the day. You would do that by allocating more of your purchase price to land and less to the building.
Of course, most people who have rental properties are probably in the higher tax brackets to begin with, so it’s usually worth maximizing your depreciation. And if you can 1031 exchange at the end instead of selling and recognizing all that gain, so much the better.
So much of my past has been about goal setting and particularly about net worth numbers…If fact numbers in general, net worth, blood pressure, steps per day, golf score, yearly income, properties and companies owned, girlfriends, kids, etc. etc.
Cash flow is the real deal. It is the gold standard. If more investments, daily choices, school studies, employment decisions, risk taking, capital investments, and probably most important time investment should be focused on cash flow maximizing….