The Rich Invest for Cash Flow. The Others Aim for Capital Gains.

DECEMBER 8, 2018

Have you lost money or got burnt from an ‘investment’?



Perhaps, you did. It can be painful. The level of hurt or ego bruised depends on how emotionally attached you are with money.

For years, I have received private emails where readers shared their failures on ‘investing’. Many were disappointed. Here, I’ll list down some of their blunders when it comes to ‘investing’:

– I lost 16% from my unit trust investment.

– My stock portfolio is downed by 30% in 6 months.

– I bought Bitcoin when it was US$ 11,000. Now, it is US$ 3,300.

– I am still trying to sell my property. The mortgage is now ‘eating me alive’.



Perhaps, you may share some of the same experiences as mentioned above. If you did, let us think for a moment: ‘Why did you make that ‘investment’ in the first place?’ ‘What was your objective at that point of time?’

Recently, I read a book, ‘Who Took My Money?’, written by Robert Kiyosaki. In Chapter 2, he shared the difference between a person who invest for cash flow and one who invest for capital gains. In most cases, their difference lies in their mindset and words spoken. For instance,



Words of a Cash Flow Investor

– I received an average of 5% dividend yield from my stock investment.

– The gross rental yield from my investment property is 4% per annum.

– ABC Bhd has made RM 0.50 in EPS in 2018, up from RM 0.45 in 2017.



Words of a Capital Gains ‘Investor’

– I bought BCD Bhd at RM 0.50 and sold it for RM 1.00.

– I bought an under construction property for RM 300k and flipped it for RM 500k.

– I expect my unit trust to go up by 8% per annum.



The Common Denominator

As I read, I realised that the common denominator for failures and losses from an investment stems from one’s desire to achieve capital gains. Most made an investment hoping that ‘it will go up’ and not ‘produce cash flows regularly’. It has become a root cause for many heartaches, hurts and even sleepless nights.


How to Reduce Risk Significantly from Your Next Investment?

I believe, one of the answers is to have a greater appreciation of ‘cash flows’. It is cash flow that makes the rich truly rich and the wealthy truly wealthy. Here, I would share how the ultra-rich got themselves richer from the same vehicles of investment that most people invest into today.



Example 1: Who Makes Big Bucks from Unit Trust?

Is it the investors or the companies that are selling unit trust as an investment?

I think the answer is obvious. But, please be mindful that I am not here to start a blame game. Instead, my intention is to explain a major difference in mindset between unit trust investors and unit trust companies.

Think about it. Most bought unit trust because of promises of capital gains over the long-term. Very few, or none at all, is mentioned about its ability to bring in cash flow. Most agents promoted ‘dollar-cost-averaging’ as a smart investment strategy in unit trust. From it, millions of investors poured in millions or billions of Dollars per month into unit trust funds in search of ‘Capital Gains’.

So, what does it mean to unit trust companies?

Answer: Abundance in Cash Flows. First, they earn sales charges from each unit transacted from their investors. Second, they earn annual management fees on their unit trust funds regardless of their performances. If a fund made profits, it pays itself higher fees. If a fund incurred losses, it pays itself lesser fees.

It means, unit trust companies will ‘more or less’ guaranteed themselves stable sources of ‘Cash Flows’ regardless of how their funds performed in the future.

Let us use Public Mutual as an example to illustrate how an ultra-rich looks unit trust as an investment. Apart from sales charges and management fees, I found that a handful of its funds invest their investors’ money into Public Bank. This is brilliant as Public Bank is receiving tons of capital ‘interest-free’, which allows it to be well-capitalised. Hence, to an ultra-rich, unit trust is a Cash Flow Business and an effective vehicle to raise funds consistently.

I am not sure how well you did in your unit trust investments. But, as for Public Mutual, it has achieved CAGR of 15.3% in profits before tax (PBT) over the past 10 years. Its PBT had grown from RM 183.3 million in 2008 to RM 660.9 million in 2017.



Source: Annual Reports of Public Bank Bhd



Example 2: Why Value Investors Like Public Bank Bhd?

Answer: Abundance of Cash Flows.

For a start, most ‘investors’ are not really investing. They are trading, gambling, or speculating. How do I know? Simple. If I asked, ‘Why did you buy the stock?’ and his reply is, ‘I expected it go up because its stock price went up or down by 20% or 30%.’, then I know, chances are, he is a speculator or gambler.

Investors view stocks as businesses. Investing is about being a part-owner of an enterprise. Instead of chasing stock prices, investors read annual reports. Why? Because they want to know, whether or not, the business is profitable and has the capability to generate ‘Cash Flows’ consistently.

Take a look at Public Bank Bhd. Its shareholders’ earnings have grown by CAGR of 8.7%, up from RM 2.6 billion in 2008 to RM 5.5 billion in 2017. If an investor bought shares of Public Bank at the start of 2008 and held it to today, he would have made total returns of 171.5%, consisting of 125.4% in capital gains and as much as 46.1% in dividend yields. Hence, it is ‘Cash Flows’ that leads to ‘Capital Gains’ for a savvy stock investor.


Source: Annual Reports of Public Bank Bhd





Source: Google Finance



Example #3: How to Build Wealth Faster than Flippers?

Let us use two men in their 30s as examples: Tom and Jerry.

Tom is a flipper. He had bought an under-construction property at RM 400,000 with the intention of selling it at RM 600,000 upon receiving his keys to his unit upon completion. 4 years later, he managed to dispose his unit for RM 600,000 after receiving his keys. After deducting a RPGT of 20%, his final gain works out to be RM 160,000. Awesome!

Jerry is an investor. He bought a property for RM 400,000 in a sub-sale market and rents it out for RM 1,400 a month. Based on a DSR calculation of 60%, the amount of monthly instalments Jerry is eligible for has increased by RM 840 a month. Based on the Rule of 200, Jerry’s mortgage eligibility would be revised upwards by another RM 168,000.

Unlike Tom, Jerry is able to ‘cash out’ the RM 168,000 to fund his purchase of a new property almost immediately without the need to sell his current property 4 years later at a higher price. Why? Because Jerry is receiving Cash Flows from his property and bankers are happy to extend mortgages to investors as rent is recognised as one of the viable sources of income.

This explains how property investors are able to keep on buying properties one after another. The answer lies in Good Cash Flow Management.



5 Lessons to be Learnt

In short, I hope that you have a much better appreciation about the differences between cash flow and capital gains and why the rich gets even richer and how most people lost money in their investments. Here, I’ll leave you with 5 lessons that could be learnt from this article:

1. The Rich invests for Cash Flows. The Rest aim for Capital Gains.
2. Never invest just because ‘it will go up.’
3. Many lost money in an investment because of lack of skill, knowledge, and know-how but yet have a desire to achieve capital gains.
4. Capital Gain Investors tend to handover money to Cash Flow Investors.
5. Cash Flows often leads to Sustainable Capital Gains in the long run.

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.

https://kclau.com/investment/cashflow/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Kclau+%28KCLau%27s+Money+Tips%29

Return Characteristics of Equity Securities

The two main sources of an equity security's total return are:

• Capital gains from price appreciation
• Dividend income

The total return on non-dividend paying stocks only consists of capital gains.

Investors in depository receipts and foreign shares also incur foreign exchange gains (or losses).

Another source of return arises from the compounding effects of reinvested dividends.

Portfolio Management - Return Objectives and Investment Constraints

Return objectives can be divided into the following needs:

1. Capital Preservation - Capital preservation is the need to maintain capital. To accomplish this objective, the return objective should, at a minimum, be equal to the inflation rate. In other words, nominal rate of return would equal the inflation rate. With this objective, an investor simply wants to preserve his existing capital.

2. Capital Appreciation -Capital appreciation is the need to grow, rather than simply preserve, capital. To accomplish this objective, the return objective should be equal to a return that exceeds the expected inflation. With this objective, an investor's intention is to grow his existing capital base.
3. Current Income -Current income is the need to create income from the investor's capital base. With this objective, an investor needs to generate income from his investments. This is frequently seen with retired investors who no longer have income from work and need to generate income off of their investments to meet living expenses and other spending needs.

4. Total Return - Total return is the need to grow the capital base through both capital appreciation and reinvestment of that appreciation.

Investment ConstraintsWhen creating a policy statement, it is important to consider an investor's constraints. There are five types of constraints that need to be considered when creating a policy statement. They are as follows:

1. Liquidity Constraints - Liquidity constraints identify an investor's need for liquidity, or cash. For example, within the next year, an investor needs $50,000 for the purchase of a new home. The $50,000 would be considered a liquidity constraint because it needs to be set aside (be liquid) for the investor.
2. Time Horizon - A time horizon constraint develops a timeline of an investor's various financial needs. The time horizon also affects an investor's ability to accept risk. If an investor has a long time horizon, the investor may have a greater ability to accept risk because he would have a longer time period to recoup any losses. This is unlike an investor with a shorter time horizon whose ability to accept risk may be lower because he would not have the ability to recoup any losses.
3. Tax Concerns - After-tax returns are the returns investors are focused on when creating an investment portfolio. If an investor is currently in a high tax bracket as a result of his income, it may be important to focus on investments that would not make the investor's situation worse, like investing more heavily in tax-deferred investments.

4. Legal and Regulatory - Legal and regulatory factors can act as an investment constraint and must be considered. An example of this would occur in a trust. A trust could require that no more than 10% of the trust be distributed each year. Legal and regulatory constraints such as this one often can't be changed and must not be overlooked.

5. Unique Circumstances - Any special needs or constraints not recognized in any of the constraints listed above would fall in this category. An example of a unique circumstance would be the constraint an investor might place on investing in any company that is not socially responsible, such as a tobacco company.

The Importance of Asset AllocationAsset Allocation is the process of dividing a portfolio among major asset categories such as bonds, stocks or cash. The purpose of asset allocation is to reduce risk by diversifying the portfolio. 

The ideal asset allocation differs based on the risk tolerance of the investor. For example, a young executive might have an asset allocation of 80% equity, 20% fixed income, while a retiree would be more likely to have 80% in fixed income and 20% equities.
Citizens in other countries around the world would have different asset allocation strategies depending on the types and risks of securities available for placement in their portfolio. For example, a retiree located in the United States would most likely have a large portion of his portfolio allocated to U.S. treasuries, since the U.S. Government is considered to have an extremely low risk of default. On the other hand, a retiree in a country with political unrest would most likely have a large portion of their portfolio allocated to foreign treasury securities, such as that of the U.S.

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/portfolio-management/return-objectives-investment-constraints.asp#ixzz1yfCssLbg

Why should I invest?

Why should I invest?


One of the most compelling reasons for you to invest is the prospect of not having to work your entire life! Bottom line, there are only two ways to make money: by working and/or by having your assets work for you. 

If you keep your money in your back pocket instead of investing it, your money doesn't work for you and you will never have more money than what you save. By investing your money, you are getting your money to generate more money by earning interest on what you put away or by buying and selling assets that increase in value. 

It really doesn't matter how you do it. Whether you invest in stocks, bonds, mutual funds, options and futures, precious metals, real estate, your own small business, or any combination thereof, the objective is the same: to make investments that will generate more cash for you in the future. As they say, "Money isn't everything, but happiness alone can't keep out the rain." 

Whether your goal is to send your kids to college or to retire on a yacht in the Mediterranean, investing is essential to getting you where you want to be. 

Read more: http://www.investopedia.com/ask/answers/153.asp?ad=feat_invest101#ixzz1xvOolCKE


How does a person gain from an investment?
There are two main ways in which a person gains from an investment. The first is by capital gains, the difference between the purchase price and the sale price of an investment. The second is investment income, the money paid to the holder of the investment by the issuer of the investment. Depending on the type of investment, the source or mix of the total gain will differ. And in some cases, these different sources are taxed at different rates, so it is important to be aware of each. 

All stocks can generate a capital gain as the price of a stock is constantly changing in the market. This allows you to potentially sell for a higher price than what you bought the stock for originally. Some stocks also generate income gain through the payment of dividends paid out by a company from its earnings. For example, say that you bought a stock for $10 and the company pays off an annual dividend of $.50, and after two years of holding the stock you sell it for $15. Your capital gain is 50% ($5/$10) and your income gain is 10% ($1/$10) for a total gain of 60% ($6/$10).

Read more: http://www.investopedia.com/ask/answers/06/investmentgains.asp?ad=feat_invest101#ixzz1xvSiTT3n

Nice way of depicting total shareholder returns

Regular Income versus Capital Gain

An investment usually produces a combination of regular income and a capital gain. 

Different types of investment produce different combinations of these two types of return to the investor.

Some investments produce only a regular income without any capital gains; for example, fixed deposits.  While at the other extreme, some investments produce no regular income but promise the possibility of high capital gain; for example, investment in gold or diamonds. 

An investment which relies on capital gains alone is a much more risky investment than one which provideds a regular income. 

An investment which relies on capital gains alone to reward its investors is less attractive than one which provides the investors with regular income because the former is much less certain than the latter.  Furthermore, it is only received right at the end of the period of investment. 

An investment which relies on capital gains to reward its investor usually (but not always) produces much higher return than one which relies on regular income.

The above principles are similarly applicable to share investment and putting money in long term fixed deposits.  Over the long run, the return on an investment of shares is very much higher than the return on fixed deposits.  Historically, in Malaysia/Singapore, the return on share investment had been about twice as high than that obtainable on fixed deposit (based on past ten years' record}.

Why dividends are important for investors' portfolios.

There are 2 paths of returns for the stock investors. These are:

1. Capital appreciation
2. Dividend yield.

Although every investors hope for capital appreciation, hope is not a really sound investment strategy.

We need something more concrete and more dependable, that is when dividend comes in.

Dividend being paid on a regular basis provides a more dependable return. You know you get a tangible return on your investment whenever the dividend is in your pocket, to either spend on your need or to be re-invested.

http://www.moneyshow.com/video/video.asp?wid=3508&t=3&scode=009393&th=1

Also read:
3 measures of a stock's value

3 measures of a stock's value

Value can be a subjective term depending on who is talking about it and how they measure values for themselves.

3 long-held fundamental measures of value are:

P/E
P/B
DY

Price: Price by itself without any other analytical factor is in fact worthless.

Earning: Earning can be a nebulous figure. Earnings can be modified and adjusted according to what the company's needs are. Sometimes if the company likes to have a different tax basis for one quarter, they may adjust their earnings up or earnings down. There are companies that depress earnings for one quarter and then lifted up earnings the next quarter to facilitate selling of stock options to important executives.

Earnings are what accountants say they are. P/E s are somewhat suspect, because earnings themselves can be suspects.

Book value: Book value also can be quite nebulous.

Often a company carries an asset at cost of 30 years to 40 years ago. Therefore, the book value does not give measure of true value of these assets of this company.

Dividend: Dividend tells us 3 things.

1. Dividend can only come as a result of earnings. In other words, company cannot pay what it doesn't have. In order for a company to pay dividend, it has to have earnings. This let us know that the company we are investing in, is a profitable concern.

2. Dividend represents income. It is a tangible return on your investment you receive every quarter. It is cash in your pocket. You can spend it on your needs, or you can reinvest that dividend into other dividend paying stocks and compound your returns.

3. Dividend helps us provide a basis for value. High quality stocks have some shared characteristics and repetitive patterns. These stocks tend to trade between 2 different bands of dividend yield. One band is when the price is low and the yield is high. The second band is when the price is high and the yield is low. Also, these stocks tend to trade in between these 2 bands over long period of time which gives us a good range to understand when to buy the stock and when to sell the stock.

To summarise: Dividend does 3 things.
1. It shows us our company is a profitable concern.
2. It puts income into our pocket.
3. It tells us when to buy and when to sell a stock.

http://articles.moneycentral.msn.com/learn-how-to-invest/new-investor-center-video-ap.aspx?cp-documentid=9d33155e-df9b-43b7-8535-9f2a8d87c769

Also read:
Why dividends are important for investors' portfolios.

Four Investment Objectives Define Strategy

Four Investment Objectives Define Strategy
By Ken Little, About.com

In broad terms, four main investment objectives cover how you accomplish most financial goals.
These investment objectives are important because certain products and strategies work for one objective, but may produce poor results for another objective.

It is quite likely you will use several of these investment objectives simultaneously to accomplish different objectives without any conflict.

Let’s examine these objectives and see how they differ.

Capital Appreciation

Capital appreciation is concerned with long-term growth. This strategy is most familiar in retirement plans where investments work for many years inside a qualified plan.

However, investing for capital appreciation is not limited to qualified retirement accounts. If this is your objective, you are planning to hold the stocks for many years.

You are content to let them grow within your portfolio, reinvesting dividends to purchase more shares. A typical strategy employs making regular purchases.

You are not very concerned with day-to-day fluctuations, but keep a close eye on the fundamentals of the company for changes that could affect long-term growth.

Current Income

If your objective is current income, you are most likely interested in stocks that pay a consistent and high dividend. You may also include some top-quality real estate investment trusts (REITs) and highly-rated bonds.

All of these products produce current income on a regular basis.

Many people who pursue a strategy of current income are retired and use the income for living expenses. Other people take advantage of a lump sum of capital to create an income stream that never touches the principal, yet provides cash for certain current needs (college, for example).

Capital Preservation

Capital preservation is a strategy you often associate with elderly people who want to make sure they don’t outlive their money.

Retired on nearly retired people often use this strategy to hold on the detention has.

For this investor, safety is extremely important – even to the extent of giving up return for security.

The logic for this safety is clear. If they lose their money through foolish investment and are retired, it is unlike they will get a chance to replace it.

Investors who use capital preservation tend to invest in bank CDs, U.S. Treasury issues, savings accounts.

Speculation

The speculator is not a true investor, but a trader who enjoys jumping into and out of stocks as if they were bad shoes.

Speculators or traders are interested in quick profits and used advanced trading techniques like shorting stocks, trading on the margin, options and other special equipment.

They have no love for the companies they trade and, in fact may not know much about them at all other than the stock is volatile and ripe for a quick profit.

Speculators keep their eyes open for a quick profit situation and hope to trade in and out without much thought about the underlying companies.

Many people try speculating in the stock market with the misguided goal of getting rich. It doesn’t work that way.

If you want to try your hand, make sure you are using money you can afford to lose. It’s easy to get addicted, so make sure you understand the real possibilities of losing your investment.

Conclusion

Your investment style should match you financial objectives. If it doesn’t, you should see professional help in dealing with investment choices that match you financial objectives.

http://stocks.about.com/od/investingstrategies/a/021906technque.htm