Financial freedom is a condition in which we should no longer have the need to work except to set up our investments and keep ourselves informed, because the world evolves as well as the types of assets that may no longer be as effective as a few years ago .
Basically, however, it should be an activity that is certainly not full-time, which leaves considerable space available, which is why those seeking to achieve financial independence should favor cashflow to capital-gains.
Let’s stop for a moment and give a definition to these two types of revenues.
Capital gain: it is a generally “higher risk revenue” with respect to the cash flow but which can lead to higher profits in the investor’s pockets.
Basically, the investor gains on the margin realized between the purchase of an asset and the sale of the same at a price higher than the purchase price.
This margin constitutes profit.
For example: buying shares on the stock exchange assumes, if the transaction is successful, that they will be sold at a higher price, generating profit (capital gain) for the shareholder.
Or again, buying a foreclosed house, beautifying with a home staging operation, minimizing the cost of accommodation and selling it at a higher price, also realizing a margin here.
Operations of this type can generate high margins in relatively short times.
The possibility of making big profits pushes most people, on the emotional wave, to prefer this type of investment , underestimating the risks, which are generally high or at least equated with the return.
Moreover, those who use this investment strategy must constantly work to capitalize on their capital, since, having realized a capital gain, it is necessary to reinvest the money in another operation that generates capital gain and so on.
Those who work in this way are sometimes subjected to a considerable amount of stress that not everyone can tolerate.
Cashflow : this is a revenue generated by a “less risky” investment compared to the operations of capital gains, generally the profits made are less elevated but constant compared to those obtained with capital gains.
An extremely positive thing about this type of investment is that, after setting it up , it goes on by itself and needs to be calibrated from time to time, some small adjustments what it requires.
Adapting perfectly to the philosophy of financial independence , which presupposes as said to “not work” and have a lot of time available .
An example of a cashflow investment can be a house bought and put on rent, it constantly generates a monthly rent, little money compared to the liquidity used to buy the property, but still a “safe” and constant income.
Another example would be to subscribe a bond, even this financial product carries a constant sum in your pocket (the coupon detached from the bond), so the capital gain that will be realized is quite safe (unless it happens unfortunately that the company that has issued the bond fails, in this case we could lose the entire capital invested …) and we have ” certainty ” that it enters our pockets (the coupons are paid on a regular basis to the subscriber) .
Of course it must be said that in order to obtain satisfactory returns, it is necessary to have a good availability of capital, something that not everyone has , at least at beginning.
We summarize below the characteristics of the two types of investment:
|“More risky”||“Less risky”|
|More profit||Less profit|
|Profit achieved even in a short time||Profit achieved in medium / long times|
|You can invest even with “little capital”||It is necessary to have a good availability of capital|
|It’s a continuous job||It requires an initial effort , then the investment generates profits constantly and no longer needs the initial work supply|
|Adrenaline||You sleep better 🙂|
I conclude by comparing the investment from capital gain to the seductive power of the dark side of force (Star Wars) while the cashflow to the luminous side of the jedi.
I liked to introduce this nice metaphor because it seems to me to represent quite clearly what may be the pitfalls behind a capital gain compared to the cashflow investment .
If we leave ourselves seduced by the dark side of the force, with the illusion of easy and big profits and we have a bad management of our money (for example, we invest all in risky shares), we risk really, in the worst case, of losing everything.
You must dominate your emotions, if you are dominated by emotion you can underestimate the dangers and make big mistakes! (We do not make the mistake of Darth Fener! 😉 )
Apart from this digression, to better describe the dangers that lie behind capital gain investments,
better to move towards capital gains or cashflow investments ?
Clear that an objective answer to this question can not be given because it depends a lot on our character and character.
However, there are some guidelines that in my humble opinion should be borne in mind.
A famous American financial coach (Robert Kiyosaki ) during his seminars, to instruct his students use a game he designed ( cashflow 101).
It is in fact known that simulation, through play, stimulates more the learning of practical notions, compared to a theoretical lesson, and since an investor must act, the simulation is appropriate in this context.
In short, the aim of the game is to make a series of investments that generate more and more cash flow until the accumulated monthly income does not fully cover your monthly living expenses for your livelihood.
If you reach this goal you have won because you came out of the so-called rat race, the mechanism for which you are forced to work to be able to support yourself.
Playing cashflow Kiyosaki teaches that, especially at an early stage, when the Monthly cashflow is still low, trying to increase it with capital gain investments is not a bad idea.
After all, even himself , before becoming owner of numerous properties in the USA, he bought shares to increase his cashflow , and still uses them, even if they do not cover the largest part of his business of course.
When in the game you draw the purchase stocks card does not put it in the deck, if stocks are at the market minimum buy several shares, then resold realizing profits that then slowly allow you to buy your first property !! …
I therefore believe that, especially at an early stage of building a portfolio, but also afterwards, a maximum of 10% of one’s capital can be invested in shares.
Attention!, however, no more than 5-10%, not to be exposed to the possibility, not very remote , if you make big mistakes, to lose all your money!.
In the worst case scenario, you will lose at most a 10%, but at best you can make sumptuous capital gains.
(I want to clarify that this is a clearly subjective and personal opinion, and I’m not suggesting to do this! Anyone is free to manage his portfolio in his proper personal way!).
Of course, trading is not a simple activity, you need to know very well when and what to buy, you need to be an expert and learn in practice, sometimes making expensive mistakes….
Although knowing very well the technical analysis,it’isnt sure that you’ll constantly realize a profit.
There are those who question the effectiveness of technical and cyclical analysis and who argue that the stock exchange is subject to an absolutely random trend that can not be predicted.
I believe that make a trader as your job you must have continuous skills and dedication as well as a particular character and a strong capacity to tolerate continuous stress, tenacity and out of ordinary confidence in your own capacity.
Instead analysis of the fundamentals is a bit different for medium/long term investments, but also in this case we need to be well informed about the state of health of company, follow company earnings and so on.
In summary then I prefer cashflow revenue , but I think it is a smart strategy to allocate a small percentage of its protafoglio , to make perhaps more risky investments, but that can generate great profits.
To use a methaphore is as if I decided to buy a lottery ticket, I know I have little chance of winning the prize, but I can afford to buy ita t most I lose 15 dollars, this doesn’t change my life , but if I win the prize my life could be changed!.