Calculating Interest 5: Cash Flow vs Appreciation

Cash flow is the income an investment gives to its owners. It can also be called dividends or distributions. Appreciation, on the other hand, is the growth of the investment itself.

If you own a rental property, the rent you receive, after you paying all your expenses and your mortgage, is cash flow. And appreciation is how the investment increases in value each year.

But which one makes you more money, cash flow or appreciation?

Let’s say you put $10,000 into an investment that has no cash flow, but it appreciates by 10% each year. In Year 1, it grows to $11,000. In Year 2, it grows to $12,100. In Year 3, $13,310. And so on.

Now let’s say you put $10,000 into an investment that gives you 10% cash flow each year, but no appreciation. In Year 1, your investment is still worth $10,000 and you receive $1,000 in cash flow. Your total is $11,000. That’s the same as our appreciation example.

Let’s say you reinvest that $1,000 cash flow into another 10% cash flowing asset. In Year 2, your initial investment is still worth $10,000 and it gave you another $1,000 in cash flow. And your Year 1 investment is still worth $1,000 and it gives you $100 in cash flow. Your Year 2 total is $12,100 ($10,000 + $1,000 + $1,000 + $100 = $12,100). Year 2 is also the same as our appreciation example.

We could keep going, but you probably get the idea. Both investments make you the same amount of money, as long as you always reinvest your cash flow.

So which one is better? It depends. The main benefit of an appreciation only asset, is that you don’t have access to your money unless you sell. The main detriment of an appreciation only asset, is that you don’t have access to your money unless you sell.

The main benefit of a cash flow only asset, is that you get access to money often and then you reinvest it. The main detriment of cash flow only asset, is that you get access to money often and then you reinvest it.

Do you prefer to set it and forget it? Lean more heavily on appreciation. Do you prefer to have options? Lean more heavily on cash flow.

What do you think?
Joseph

This is a series. Here is the previous post. Here is the next post.