If you rely on your investments for income, an important aspect of managing your portfolio is cash flow. Correctly structured cash flow is critical, so let’s have a look at what you might need to think about.
What is cash flow?
Cash flow simply looks at the payment frequency of income from an investment. This income is paid regularly (ie. monthly, biannually, annually), but can sometimes be erratic, particularly for longer term investments, such as private equity.
It differs from the 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.
Why is cash flow important?
It’s important to understand the cash flow components from your portfolio for two main reasons:
It’s a fundamental step in having an effective personal financial budget. While you may be receiving income from an investment, if the income doesn’t arrive regularly enough to meet living expenses, you will need to access cash from other sources to bridge the gap. This might involve getting a cash advance from a credit card at high interest rates (never a good option), or reducing (or possibly eliminating) your monthly savings.
Uneven cash flow makes accelerated debt reduction difficult to achieve. Due to the high initial costs involved, many of us go into debt to purchase items such as cars. However, this debt comes at a price: while you are carrying it - you cannot use these funds to invest elsewhere. It makes financial sense to reduce lifestyle debt as quickly as possible so that these funds can be used to invest in financial assets that will appreciate in value to create enduring wealth.
Consider cash flow diversification
Diversification doesn’t stop at your choice of investment assets. You need to consider it from a cash flow perspective too. It is essential to have a sufficient mix of underlying assets within your portfolio so that a relatively even income is received throughout the year.
While some investments may look similar at first glance, a prime differentiator between them may be the frequency of dividend, distribution or yield payments and the terms on which they are paid.
Understanding cash flow is crucial to being able to maintain a budget, and following a workable budget is the key to efficiently managing your wealth and achieving your financial goals.
Ask us for further guidance on how to manage your investment cash flow.