Capital Gain vs Cash Flow

When it comes to making a decision on investing, would you choose one based on the criteria of capital gain or cash flow? It's a tough one, isn't it? Frankly, the answer varies from person to person. However, i would say that for most ordinary people, they would prefer capital gain.

Let's quote an example, suppose you purchase an asset for x amount of dollar and sold it for a nice 40% gain in 3 years, versus you purchase an asset for the same amount that gives you say 8% annual return in the form of dividend or rental for instance, and the asset only appreciates less than 5% a year. For most people, they would probably go for the first example, where higher capital gain is made. After all, it sounds more convincing and exciting when you tell your friends or business partners that you have pocketed handsomely in this deal!

Question is, what do you do with the money gained thereafter? Most commonly, there is always a lurking temptation to spend on luxury items when you have spare cash in hand, be it a luxury holiday, fancy car, watches, etc. After all, why wouldn't you want to pamper yourself a "little" for closing a wonderful deal! Nothing wrong with pampering yourself sometimes (good way to recharge the batteries!), but it's the quantum of spending unecessarily that you would want to take caution of. Bear in mind, spending unnecessarily means you are giving away an opportunity to make money work for you in the future!

On the other hand, can you find another opportunity that can give you similarly good financial returns after this? Chances are you may not. So you will end up with plenty of cash on hand and as time passes, the temptation to spend grows!

For me personally, although short term capital gain sounds sweet and exciting, there is no guarantee that a particular investment will yield the expected capital gain. Therefore the risk increases. On the other hand, human nature to spend unnecessarily is also a lurking danger. On the contrary, an investment that can generate a regular streams of income (cash flow) is perceived to be lower risk and helps to sustain your own personal financial position in the longer term. To take one step further, go for investments which generate positive cash flows.

Positive cash flow simply refers to the excess regular income generated by an asset after deducting all the relevant expenses in deriving the particular income. A good example is property rental income where the tenant will pay the property owner rental every month as long as the property remains tenanted.

A good point of comparison is between landed property and rental yield property such as high rise residential apartment. Landed property has bigger potential for capital gain (but not guaranteed) but poor rental yield. That means extra burden having to regularly service the commitment from your own pocket and opportunity cost! On the contrary, good high rise apartment may not generate as high capital gain but gives much better return when it comes to rental yield. In this case, the tenant will finance your property but the property is still owned by you!

A long lasting positive cash flow will help a person or a business to survive and sustain longer, without the need to continuously spend more money and therefore sacrificing other opportunities. As you build more businesses or acquire assets that generate positive cash flows over time, you will find that you have truly gained the ultimate goal of financial freedom!

Nevertheless, that doesn't mean you should ignore capital gain all together! Why not the best of both worlds? According to Robert Kiyosaki, the key to financial intelligence is how to use both cash flow and capital gains to grow wealthy. So many people are not successful, because they’re generally focusing on only one of the two.

Dividend Yield? Don't Bank On It!

At a challenging time like this, more and more companies are slashing their dividend payout to conserve cash for either future defensive or offensive measures. Some time ago i have written the possibility of such scenario happening and how true indeed.

JP Morgan, U.S. second-largest bank, slashed its common stock dividend by 87%, a surprise move by a lender considered among the strongest in the U.S. financial sector. This came about despite the bank claiming a "solidly profitable" quarter, and that the outlook being in line with expectation.

It's decision to lower its quarterly dividend to 5 cents per share from 38 cents will save US$5 billion of common equity a year and hopes to pay back the US$25 billion of capital it got in October from the U.S. government's Troubled Asset Relief Program faster.

Among others, Bank of America and Citigroup, have in fact slashed their quarterly dividends to a penny per share since November 2008!

It is highly expected that more companies across the globe will continue to slash dividends in order to conserve cash.

Locally in Malaysia is no exception, whereby Carlsberg Brewery Malaysia announced an unprecedented reduction in dividend distribution by 60% compared to the past. In the past, such company has never failed to give out high dividend yields from the range of 8% to 10%.

With the current global financial crisis and recession looming, one should not blame them for being conservative. After all, no one knows how bad the situation may pan out. It's better be safe than sorry!