Cash, which is essentially money, is a very powerful tool. With cash, you have the highest degree of liquidity and you have the power to do many things. How powerful your money is depends on how well you are able to grow it. If you have lots of cash, most of the time it is a good sign, but keeping too much cash may not be smart to do. We all know the importance of cashflow, but when it comes to investments, some people tend to overlook it. Today, I am not going to emphasise a company's statement of cash flows, but YOURS!
If a company is cash-rich, will you put money into it? Not necessary. If a company has many contracts and projects, would you? Most likely. Cash/ Money is as earlier mentioned, powerful if you can grow it. If you place your money in the bank today, you might get a 3-4% interest payment a year. Your cash is growing, but the fact is, it is quite little and everyone can do it.
I mention Rich Dad very frequently because I have learned a lot from his books. One of is his most valuable topics is defining an asset which I believe in. If you have read his books, he always mentions that assets are things that put money in your pocket and liabilities are the opposite. And the famous example is classifying your house as a liability. Your house or property is placed into the asset column of your balance sheet according to accounting principles. But is your house really an asset? People get very irritated when being told their house is a liability because they put so much effort into buying, building, furnishing and everything. And their biggest argument is, "I bought my house 10 years ago at $200,000 and now it is worth $400,000". That argument is sort of valid, because you can sell it for more which puts money in your pocket. And that is if you sell it!
Appreciation in real estate prices is very important when we buy one. But the fact that we can sell it for more might not be such a good criteria for deciding whether it is a good investment because we got no place to stay if we sell our house!!! If you have used the Net Present Value (NPV) calculation before, I think you will realise why. Assuming perpetuity, if you draw the timeline from time 0 to probably 60 years of your house. So at time 0, you bought the house, negative $200,000 plus some renovations another negative $50,000. For time 1 onwards, you got maintenance, upkeeping, council rates and interest on loan. Guess what, the entire timeline is NEGATIVE ALL THE WAY!! The NPV is a huge negative.Is that a big liability or what?? Indeed, the negative cashflows from time 0 to infinity tells you the house you live in is not an asset, but the opposite. Just like a car as well, a huge liability till the end, but as we need those two to survive we got no choice. If the investment does not generate positive cashflows, it probably isn't an investment or asset.
I know very little about real estate, but I will always remember the rule of positive cash flows. I know it might seem hard, but I've seen it happen on many cases, When investing in real estate, make sure you are generating positive cash flows from the investment. It means your rent income must at least be able to cover the expenses and repayments. It is tough to do if the perccentage of the loan of the real estate is high. That is why, you need to at least try to put a larger downpayment to ensure your cash flows are positive subsequently. And this is when real estate becomes an asset/investment. Rich Dad asked Robert in one of his books. "If all your real estate generates a positive cash flow, how many can you own?". The answer was simple "As many as I want to".
The NPV rule is quite a simple rule to use and it is very evident it is very accurate. It uses cash flow to determine whether an investment is good. The dividend-discount model is one of the few used to place a value on stocks, estimating future cash flows. As for speculators who trade frequently to make capital gains, it is also applicable. If you sell your investment for a higher price than you paid for, its NPV is most likely to be positive (time value factor). Rich Dad's asset definition also fits. If you sell a stock for a gain (assuming no dividends), you put money into your pocket and that makes it an asset. It is a bit ambigious in this case because you only classify the stock as an asset after you sell it.
This may be my last post in awhile because my holiday is just about to end. I think work will take most of my time. This post is really easy to understand for many, but its power of application is the powerful part. I hope this post and my previous few builds the foundations to investing successfully in the future. Thanks for reading :)
~deyao~
