Many investors debate whether it is better to invest for cash flow- regular income from rent, interest, or dividends, or appreciation, which is the increase in an asset’s value over time. Each strategy has its pros and cons, and the right approach for you depends on your financial goals and risk tolerance.With the cash flow vs appreciation debate, there is no objectively better choice. Cash flow investments tend to be a lower risk but generate modest returns. Appreciation investments, like those pursued by commercial property flippers, usually provide higher potential returns but with more volatility and risk. An ideal portfolio for many investors combines both types of assets.
Look For Steady Income Or Build Long-Term Wealth?
Investing for cash flow means buying assets that generate regular payments, such as rental property, bonds, or dividend stocks. The appeal is that the income can provide ongoing money to live on or reinvest. However, the value of the underlying assets may grow little over time.
Investing for appreciation means buying assets that you expect to increase significantly in value over many years, such as stocks, real estate, or collectibles. The aim is to build wealth in the long run. However, there may be little or no income in the short term.
With the cash flow vs appreciation debate, there is no objectively better choice. Cash flow investments tend to be a lower risk but generate modest returns. Appreciation investments usually provide higher potential returns but with more volatility and risk. An ideal portfolio for many investors combines both types of assets.
Examining Specific Cash Flow Investments
Rental real estate is a popular cash-flow investment. After paying expenses, rental income can produce annual returns of 6-12% or more without selling the property. However, real estate values do not always keep up with inflation, and managing properties requires work.
Bonds provide semiannual interest payments. High-quality bonds yield 2-5% annually with low default risk. They gain little in value over time, though, and yields do not beat inflation. Junk bonds offer higher yields but much more risk.
Dividend stocks provide quarterly income that companies pay out of their profits. Historically, dividends have represented about 40% of the stock market’s total return. However, companies can cut or eliminate dividends, and stock values fluctuate significantly at times.To help navigate the stock market and make informed investment decisions, consider using tools like VectorVest.
Appreciation Assets: Higher Rewards But More Risk
Common stocks have the potential for strong price appreciation over many years as companies grow and the economy expands. However, in any given year, the stock market as a whole could drop substantially in value. Individual companies can see their stocks crash and investors lose most or all of their money.
Real estate also has the potential for meaningful appreciation over long holding periods. Residential housing values historically have risen slightly faster than inflation, while commercial real estate and land have generated better returns. Still, property values sometimes decline for years, and real estate lacks the liquidity of stocks.
Collectibles like art, antiques, rare coins, and vintage autos also can dramatically rise in value over decades. Yet because collectibles produce no income and have opaque pricing, they tend to yield disappointing returns for most hobbyist investors. Professionally managed funds may do better but still, underperform the stock market.
Combined Approach: Stability Of Cash Flow Plus Growth
For most investors, the ideal approach is to invest for both cash flow and appreciation by building a balanced portfolio. Holding some cash flow assets helps meet short-term financial needs and provides stability. Allocating more money to appreciation assets maximizes your potential to achieve long-term goals like a comfortable retirement.
Rebalancing a mixed portfolio also allows you to maintain your target allocations. If stocks have surged in value, for example, you can sell some to buy more cash flow assets like bonds. This systematic selling high and buying low improves your overall returns over time. Investing for both income and growth also helps ensure you have money coming in during all parts of the economic cycle.