Cash Flow vs. Appreciation vs. Tax Efficiencies – Why Not Both Or All?
You cannot get to where you need to get, if you do not know where you are headed. Or you may stumble along the way until you get on the path leading you to your desired destination. Having clear goals upfront is the first step of setting yourself up for success in achieving that goal. So are defining your investment strategy and criteria. In prior articles we discussed various aspects of investment criteria including but not limited to markets/submarkets, assets class, asset type, returns, leverage tolerance, and business strategy. In today’s quick snippet we will address the three most common investment strategies.
In a prior article, we illustrated how an initial seed investment of $50K invested at very conservative returns can generate meaningful passive income stream over a period of time, starting at ~$6,000 in Year 1 or $500/mo. If your monthly income goals are higher and you want the cash flow sooner, you can invest a higher upfront amount and also target opportunities with a higher cash on cash return. Along that train of thought, if we were to apply these numbers to the previously shared example, that means one could start with $150K and target deals with cash on cash return of 8% or more in order to achieve monthly income of $1,000 ($1,000 x 12 months = $12,000/year divided by 8% target cash on cash return = $150,000 initial investment needed).
If you are happy with your current cash flow from your W2 salary or other investments and if you are more risk tolerant, then you might be more attracted to investments with a great opportunity for appreciation. Examples of such would include new construction, flips, or land deals. Examples of such markets are LA or NY. Counting on appreciation is generally a riskier strategy and slightly more speculative as you are reliant on the market dynamics outside of your control to deliver target returns. However, it might make sense if your risk tolerance is higher and you do not need the cash flow in the interim period until the asset is sold.
For high income earners, reduction in tax liability may be a higher priority vs. the prior two strategies. Such tax liability reduction would enable them to utilize the saved $ for other purposes – business or personal. In that scenario, selecting an investment that reduces tax liability via depreciation or reduces capital gains via 1031 exchange might be the better solution.
All of the above
You do not have to limit yourself to only one strategy. In addition, your strategy can change over time based on your individual circumstances. Thus, you may decide to use a combination of all three.
Knowing your investment strategy and investment criteria will help you quickly prescreen various deals coming across your desk and pass on the ones outside of your investment box. Hopefully this will also make the investment process less overwhelming and reduce distractions, fear of missing out, or shiny objects that distract you from following your own path to financial freedom.
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.