A fundamental building block of healthy finances is spending less than is earned, and this continues through to wealthy finances.
Note: Wealth building is not sustainable if investments are causing your overall finances to run at a deficit.
If your goal is wealthy finances (serviceable levels of good debt holding income producing assets) then acquiring affordable income-producing assets with high growth potential is a must have…
Why balance equity use with cash flow management
Caution: Building wealth is reliant on investment growth, which is redundant if you are forced to sell investments prematurely; this is why my team and I, before recommending investments to clients, analyse investment affordability against financial capacity.
What is Cash Flow?
Cash flow is the net amount of cash and cash-equivalents moving into and out of your personal finances.
Cash flow differs from total income return in that it examines how often and when income is paid rather than the actual level of income received from the investment over a set period (ie a financial year).
What is Cash Flow Management?
Cash flow management is matching cash flow and frequency with investment costs and cost frequency to determine affordability. A very broad example is provided below…
Cash flow management helps to determine if an investment would cause your net personal finances to run at a deficit, the impact on current lifestyle and the degree of risk incurred through various wealth-building strategies.
In addition, cash flow management can help recognise investment potential, to avoid missing out on tens – or even hundreds – of thousands of dollars in lost income and growth from under-utilizing your financial capacity.
Cash flow management in practice…
While an investment may generate income and tax savings that will support debt reduction and wealth building…
If income and tax savings don’t arrive regularly or are not enough to service the investment debt, additional cash will be required from other sources to bridge cash flow gaps. This can involve reducing (or possibly eliminating) monthly savings, cutting back on lifestyle, or worse case – the forced sale of investments.
Unpredictable or irregular cash flow can make accelerated debt repayment a difficult goal to achieve; investment income and frequency should be considered when debt is held against investments.
Main consideration points for personal and investment cash flow…
- It is important to maintain an accurate budget
- Make sure you work from net yields when calculating investment income
- Take a ‘glass half empty approach’ and run separate forecasts that account for decreases in income and increases in expenses
- Base your investment budget on what you can afford, not what a bank is willing to lend.
Cash Flow Diversification
Diversification doesn’t stop at your choice of asset class; it needs to be considered from a cash flow perspective too. A sufficient mix of assets classes within your portfolio can even out investment income received throughout the year.
Note: On the surface two investments may look similar, however a prime differentiator may be frequency of dividend, distribution or yield payments and the terms on which they are paid.
Once my team is satisfied our client can meet holding costs, accounting for possible fluctuations in yield and investment expenses, our focus shifts to longer-term wealth building factors such as investment growth.
Why is investment growth important to long term wealth building?
Observation #1 – By year 20 the yield of investment B being $1,431,875 has almost caught up to the 10% yield on investment A being $1,653,298. You can see that the yield of each is based on the annual increasing growth amounts.
Observation #2 – In addition, 5% growth on investment A has grown to $826,649 compared to 10% growth on investment B which is now $2,863,750.
Observation #3 – In total, investment B has a cumulative return of $1,815,678 more than investment A.
Need help matching cash flow and frequency with investment costs to determine affordability?
There is always professional financial advice
In addition to working with our clients to balance equity against investment selection, lifestyle requirements, financial goals and affordability, we are also able to perform detailed scenario analysis to support our clients future investment plans.
If you would like to explore your wealth potential, I would recommend booking a personal wealth review – [click to book]
Have you seen the debt-recycling example in the Top 5 Wealth Creation Strategies for Modern Australians?
Next post we show you the effect on loan terms, interest savings, tax savings and wealth accumulation across a 20-year period… [Click to Read Now]