WHY CASH IS NOT KING
How many times have you heard the words, “Cash is king.”?
It sounds good.
Sure, it feels good to have Benjamins in your wallet. But that does not make cash king.
Cash is necessary for reserves and to pay expenses. But there is something else more important than cash.
Read on and learn what that is.
INFLATION DEVALUES CASH
What does a dollar buy today?
If you are living in a house, what is it worth today? What was it worth two years ago?
If you had $250,000 in cash to buy a house two years ago, would that $250,000 buy you the same house today?
Cash doesn’t last forever. And it buys less and less as time goes on.
Have you ever heard someone wish they had a million dollars and they would retire? How long would $1 million last? If you only spent $50,000 per year that cash would only last 20 years. But you wouldn’t expect the $50,000 next year to provide the same standard of living as it does this year, would you?
I know people who retired 30 years ago and thought they had plenty of money, but soon inflation chipped away at it. And as the cost of stuff went up, their standard of living went down.
We have enjoyed low inflation rates around 3 percent for a number of years. It has been a long time since inflation was over 5 percent. Until recently.
In 1980 inflation averaged over 13-percent. The prime rate exceeded 20-percent.
Consumer prices are up 8.5 percent for the year ended March 2022, according to the CPI index. Your actual experience may have varied. How much more are you paying for gas? Or groceries? Or property taxes?
Inflation is the reason why cash is not king.
If cash is not king, then what is? What could be more important than having cash?
WE NEED ASSETS
If you are like most savy investors you would probably not sit on $1 million in cash unless it was set aside as reserves for a much larger portfolio.
We want our money working for us, not sitting idle getting devalued. It needs to keep growing.
What’s better than cash? CASH FLOW!
My favorite way of generating cash flow is with real estate.
Sure, there is money to be made in the stock market, but the returns can be very volatile. Have you ever compared how fast a bear market devalues a portfolio compared to the slower growth in a bull market? The decline can be rapid and take years to recover.
What would a bear market do to your portfolio and retirement plans?
Real estate can provide an increasing cash flow stream.
We recognize five benefits why real estate is an IDEAL investment. Income, Depreciation, Equity, Amortization, and Leverage. Let’s take a quick look at each of these.
INCOME – Real estate provide income from rents, and can provide a cash flow stream after all expenses are paid. During inflationary periods rents can increase. But over time the loan is repaid at the same amount every month. This has the effect of increasing cash flow over time.
DEPRECIATION – This is a tax benefit that can be used to reduce tax liability. It accounts for depreciating the physical improvement to a property.
EQUITY BUILD-UP – A property tends to increase in value over time due to inflation. We can also increase equity by making improvements to the property and increasing its value above and beyond the cost of those improvements.
AMORTIZATION – When we use a loan to purchase a property and make improvements we frequently take out a loan. This must be paid back over time and is done with rental income. Many loans include both principal and interest. This continued paydown of principal is known as amortization.
LEVERAGE – Through the use of leverage we are able to purchase a greater asset than if we paid cash. Just as someone who buys a home with nothing to 20-percent down, we can purchase a commercial property with leverage. Some people have noticed that while they only put a few thousand down to get into their house, their equity may have risen by tens of thousands of dollars.
We have discussed each of these benefits of real estate in other blogs, and each can be significant.
The one benefit of real estate that allows you to hold a property through all markets, up and down, is Income. That is Income via Cash Flow.
Sure, I have had properties that provided far more income through appreciation and selling than they did by generating rental income. But the positive Cash Flow enabled us to hold the property and take advantage of the large gain in value.
Positive Cash Flow enables you to hold onto a property through changing economic conditions and thus allow time to let the other benefits work for you.
A negative Cash Flow will suck money from other sources and draw down your reserves.
If a property is overleveraged and has negative cash flow it becomes an alligator. You must keep feeding it.
What would happen if your property value drops by 20-percent?
If a recession occurs, can you adjust your rents enough to maintain positive cash flow?
There is a balance that must be maintained to optimize leverage, Cash Flow, and the other benefits of a real estate investment.
At the end of the day, Cash Flow is king.
What do you think? Is Cash really king? Or is Cash Flow king? Both cash and cash flow have their place, but cash flow should outlive cash. Let us know your thoughts.
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Mike is a retired aerospace engineer with a passion for real estate investing and teaching financial literacy. He lives with his wife in Daytona Beach, Florida.