Wednesday, November 4, 2009

Understanding Cash Flow

The term "Cash Flow" is bandied about by many folks, particularly those who are least likely to understand what it means. Many fraudsters like to use misconceptions about this term to sell schemes, such as "The cash flow system" or "cash flow notes" or some such nonsense.

In my "Net Worth" article, I illustrated how you can calculate your net worth. It is not hard to be a millionaire on paper these days. But you can be a millionaire on paper (at least) and still be cash-starved or cash-poor. It is ironic, to say the least.

But on the other side of the coin, it is possible to be completley broke, but have a high cash-flow volume, a large house, a fancy car, and lots of "things" and toys, and live an expensive lifestyle. Most people in America fall into this latter category. They appear to be wealthy, but are one paycheck away from being homeless.

It is unfortunate, but the cash-flow mentality takes hold early in most folks, and is hard to shake. Most folks work at "jobs" rather than running their own businesses. As such, they have no idea how a business is run, or what it takes to make a business profitable. They only know that they show up at such-and-such a time, work for X hours at predefined tasks, and will be paid every week a fixed number of dollars.

And of course, they expect, no demand, to be provided with such "jobs" and in fact think that the Government can provide them (which is why candidates always promise to "create jobs").

That sort of attitude towards work is bad enough. But the paycheck mentality carries over toward their personal lives as well. Trained to look at money as something that comes in weekly dribbles from their employer, each dribble is then divided up into small dribbles, called payments, which then go out to various commercial entities, banks, and financial institutions.

Thus, the paycheck is divided into house payments, car payments, cable TV payments, cell phone payments, credit card payments, etc. Little, if any is "left over" and that left over is used as "spending money" for meals and other small purchases.

Living in such a manner, one can appear "wealthy" and even believe one is wealthy, but in fact be dead broke. You can buy a large house, and be able to make the payments, but have no equity whatsoever. You can lease an expensive car, and never actually own it. Neighbors might think you are "rich", but in fact, you are only paycheck-rich, with the external appearance of wealth, and little or no actual wealth.

Why do many people chose to live this way? And is there really anything wrong with it? After all, if it looks like a duck, walks like a duck, and quacks like a duck, isn't is really a duck? The answer to this latter question is NO. The appearance of wealth and real wealth are entirely different things.

The first question is easy to answer. We live the paycheck-to-pacycheck lifestyle because we can. Moreover, society, though television and peer pressure, trains us to live this way. We are encouraged to consume, often as a patriotic duty to the economy. And of course, living this way, we get to have a lot of nice stuff NOW, without having to wait for the messy reality of earning and saving money.

But the appearance of wealth is not wealth. And one reason why the powers-that-be want you to live the cashflow lifestyle is that real wealth equates to real power. And so long as you can live paycheck-to-paycheck as a passive consumer, you will never have any real power or control over your own life. You will always be at the mercy of someone else. It is no way to live.

Having real wealth - real cash on hand - means you have incredible power at your disposal. At the present time, during this "financial meltdown" (caused largely by too many people living the cashflow lifestyle and borrowing too much) the folks with real wealth are cleaning up - getting wealthier. These are the folks who are buying up the distressed real estate for pennies on the dollar - with cash. They will hold them for a few years, renting them to people living the cash flow lifestyle, and then sell them, at huge profits, to the folks who buy-on-time using a mortgage.

You see, since there are so few people with real cash in this country, when a commodity (such as a car, house, yacht, etc.) is only available to cash purchasors, the prices plummet. Cash buyers have the best choices in goods.

And thats how the "rich get richer" as they say. Once you start to have cash-on-hand, it becomes easier to make yet more money. Once you have money, you get the best rates on loans and bank services. You get the best deals on Real Estate and purchases. So it becomes a snowball effect - the best bargains are offered to those who least need them. As Warren Buffet said, "The first Billion is the hardest".

For example, one reason used cars plummet in value at the 5-year mark is that most banks won't write car loans on older cars. Those who do (usually consumer credit companies) demand exhorbitantly high interest rates). A 5-year-old mercedes, well maintainted, is a heck of a car. And since most people don't have the cash you need to buy one (or can't pay the high interest rates to purchase one) the cash buyer can pick one up for a song - and keep it forever. That's one reason you'll see older cars like this parked at the homes of the very rich. The understand that only a fool wastes money by paying retail for a car - and paying car payments and interest.

So how do you avoid the cash-flow trap? It is hard to do, as societal pressures, along with our own weaknesses, tempt us to buy, buy, buy. We argue with ourselves that we "deserve" some luxury in our lives as a reward for "all our hard work". And to some extent, you have to spend and enjoy the present (See my article on Past, Present, and Future). Sacrificing everything in the today for some far-off tomorrow makes no sense either.

But, if you can put aside some money instead of spending it, you can start to accumulate wealth over time (see my article, "Owning Money"). Once you start to accumulate wealth, you really become wealthy. But ironically, you may not have as much of the appearance of wealth.

Take two familes, living side-by-side in a suburban neighborhood. They both make $100,000 a year. One lives the cash-flow lifestyle, leasing new cars every two to three years, holding mutliple credit cards with large balances (and interest payments), paying for expensive electronic services such as cable television, cellular phones, and the like. They spend every penny of every paycheck on things and interest and services. They feel wealthy, as they have lots of electronic toys and shiny things parked in the driveway. But they have no real wealth, as they keep refinancing their home and taking out capital to pay off their credit card debts. They charge everything on credit cards, and thanks to revolving interest, end up paying two to three times for every purchase, in interest payments.

The second family lives a real net-worth lifestyle. They buy secondhand cars, 2-3 years old (likely their neighbor's cars off-lease) and pay cash for them, saving nearly half the cost of ownership. They keep them for years before replacing them. They pay cash for most of their purchases and avoid using credit cards at all. They have not tapped into their home's equity to pay off credit card debts as a result. They eschew flashy electronic services like cell phone texting plans, or the latest gadget, or cable television, in favor of contributing more to their 401(k) plan. To outward appearances, they largely are living the same "lifestyle" as their neighbors, but have far more money in the bank and more equity in their home.

And the best part of all, it is all merely a matter of making choices. Hard choices to be sure, but choices nevertheless. Turning off the television is the first hard choice, as the television is the primary source for the cash-flow-lifestyle propaganda. Once you do that, the subsequent choices are much easier.

Will they become billionaires this way? No, not likely. But they will easily become millionaires in their lifetime. And their retirement years will be enjoyable, instead of fraught with worry as their neighbor's will be.

And that is the ultimate point. At some point in your life, you will have to get off the cash-flow bandwagon, or else be forced to live on Social Security. Unless you can put aside some money of your own, you will perpetually be at the mercy of an employer for a paycheck or the government for a pension check.

If you can accumulate wealth, rather than merely spend it, you can do very interesting things with your life - and be more independent as well. Or you can work at a job you hate for 30 years, all so you can have a Jet Ski and a Lexus.

The choice is yours.

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