01 Jun How to become Rich – Cashflow or Capital Gains?
Rich Dad will advise you to focus on building your cashflow if you want to be rich. When Dennis Ng was still alive, he would say that is not true. He got rich by capital gains. He became a millionaire by investing $250k in stocks. Who is right?
I will say both are right. In fact, you need both to be rich and there are no other ways unless you strike lottery big time. If you and I know that we do not have the destiny to win big from lotteries, we have to work our way through cash flow and capital gains. Let me give you my perspective in this post and I think it will help you frame your thoughts in a useful manner.
Role of Capital Gains
To become rich, you need to have significant capital gains. In order to have large capital gains, you need to have a sizable capital to invest with. Let’s say you invested $100k after the stock market crash in 2008 and you sold your stocks in 2013 and made $100k. Although your percentage gain of 100% is impressive, you are still far away from being a millionaire. How many times will you need to double the money to $1 million? You will need another 2 market crashes which you may only achieve in 10 to 20 years time. But if you have $500k invested in the same period, you would have become a millionaire in 1 market cycle. It is much faster to become rich through capital gains if you know how to invest.
This is the reason why the rich gets richer. They have sizable capital to invest and grow their money much faster than the average joe. Remember, the growth of wealth is non-linear due to compounding effect.
I think this is simple to understand. But the question is, how do you get a sizeable capital? The answer is not capital gains but cashflow.
Role of Cashflow
Although Dennis got rich because of capital gain, he probably down played the role of cashflow in his wealth building process. When he left his bank job, his income dipped for a few years until he setup his mortgage brokerage firm. The company was making money and Dennis had more than enough money for his expenses. The ‘excess’ money would become savings or investment capital. He had money to invest because of positive cashflow.
In other words, you need positive cashflow to build your capital. Your source of cashflow can be your salary. You need to make sure your expenditure is lower than your salary so that you can have ‘excess’ money to form your capital. If you hardly have enough savings, you need to either reduce your expenditure or increase your income. There are no other ways. Do not leverage your capital excessively to invest as you may not have the financial muscle to hold through the periods your investments are doing badly. You are setting yourself up for financial disaster.
Think of cashflow as a process which you need money to meet your daily needs. You cannot afford to wait for your capital gains to realise in 5 years because you cannot go hungry for so long. Although cashflow is vital, you cannot afford to rely on it solely because you will take a long time to become rich, if ever. Hence, investing for capital gains is still necessary.
Trading and Investing
Most people trade and invest without knowing what they want to achieve. Do they want an income or do they want to grow their money? To me, trading is cashflow and investing is capital gains. I know some people invest for dividends or cashflow but I think that is not the best way to grow wealth. When I invest in stocks, I prefer to hold over a few years. I usually buy when no one wants to, and sell when others are interested to buy. Investments, if done in such a slow and steady way, are quite easy to make money. Sometimes, you can make a few times of your capital. In my opinion, this is the best way to grow rich especially if you have sizable capital.
Trading on the other hand, is good for income. Due to the shorter time frame, you can get cashflow frequently. The amount may not be a lot but it can be enough for you to live and have some extra cash for your investment capital. The frequent but small gains are difficult to make you rich. Some people may mistake trading as a way to get rich quick and I hope by now you understand that is not true. If you have a salaried job and you are happy with it, focus on doing a good job and save up part of your salary to invest. You do not need to trade as you already have an income. Focus on investing to grow your wealth instead, you will become richer than trying to trade. This is because trading is hard and you need to spend a lot of time and effort to figure it out. You have many important things to do in life and you do not want to devote unnecessary energy to trading since it is not going to make a big difference to your wealth. Trading should only be pursued by people who want to make a living from the financial markets.
- The best way for the average joe to become rich is to invest for capital gains
- You need to have sizable investment capital in order to have gains that would make a difference to your net worth
- You need to have positive cashflow to grow your capital
- A positive cashflow is established when your expenditure is less than your income
- To increase the cashflow, you can decrease your expenditure, increase your income, and/or setup more sources of income
- Cashflow alone will take a long time for you to become rich. So you still have to invest for capital gains.
- Trading is cashflow and investing is for capital gains.
- If you have an income, you should invest and not trade.