Everyone in the personal finance blogosphere is obsessed with their net worth, in fact, they had a Rock Star Directory (which is now defunct) displaying the net worth tracker of personal finance bloggers. I admit that I am obsessed with net worth as well… in my quest to have a 7 figure net worth by age 40, however, I know in my heart every month when I calculate my net worth, that the true predictor of financial independence is actually having a healthy cash flow.
net worth means nothing if you don’t have cash flow
This isn’t to say that net worth is not important, it is… because cash flow is usually derived from something within the net worth. And with that cash flow, you can then use that money to fund your early retirement.
Case in point…since 2016 there are four cities in Canada where the average net worth is over a million dollars. These are Vancouver, Toronto, Calgary, and Victoria. This, of course, is largely fueled by the ridiculously high real estate prices.
Even though people are worth well over a million dollars, they are still in debt. Canadians’ average non-mortgage debt is over $22,000. People do not seem to be generating cash flow with the million dollar household net worth because if they were, there would likely be less non-mortgage debt.
There are a lot of households who have million dollar net worths but are considered low income or “poor”, as the owners are university students or housewives and they, therefore, benefit from a lot of Canadian government subsidized programs and services (though I am being tongue-in-cheek here now, I must admit).
One of my friends’ parents lives one of these aforementioned neighbourhoods (they are in a wealthy area but the census data show it is low income). However, there are lots of examples of people living in Vancouver who bought many years ago but actually don’t have much income and can actually barely scrape by their housing expenses.
harness your net worth to create cash flow
The key is to use your net worth to create cash flow. When you do this, you will be able to support your lifestyle without necessarily having to add to your net worth by working, and you will be able to add to your net worth if you have excess cash flow left over. This gives you financial freedom.
Despite real estate pundits beliefs, being house rich and cash poor does not give you freedom. Home equity cannot buy you food to put on the table or help you pay the bills (well, unless you tap into your HELOC which is not recommended even though borrowing costs are so low right now).
The key is to have your net worth be more comprised of investable assets (e.g. liquid assets) than non-liquid assets. This is why I think liquid net worth is more of a true measure of net worth.
Just like with a business, you need to use your assets to generate cash flow. Personally, I think the best cash flow involves a beefed up retirement nest egg, that generates passive income from dividends.
An investment portfolio of $1,000,000 with a 3.5% dividend yield will provide $35,000 in annual dividend income…whereas a 2 bedroom condo that is worth $1,000,000 provides $0 in annual income and probably $450 a month in maintenance fees alone expenses instead (provided you live in this condo and don’t rent it out of course).
Income producing assets can generate cash flow and provide financial freedom and financial independence. Even better, generating passive income in Canada through these assets helps you make money while you sleep.Here’s a list of some of them.
What are some things that can generate cash flow?
Other than a defined benefit pension’s payouts, there are other things that can generate cash flow.
This is the holy grail of passive income Canada because it is purely passive. I am a big fan of dividend income and liken it to ocean waves. Usually, dividend income is variable and I have seen it anywhere from 1% to 11% with the average yield around 3 to 4 percent. When you put your capital to be deployed in well-researched companies or even ETFs that generate dividend income, you are paid distributions on a quarterly to monthly basis.
When the companies are doing well, they will continue to raise their dividends. The raises in dividend income combats against inflation. One of my goals after my net worth goal is to have my dividend income replace my annual expenses (and more). I’m not a fan of the 4% Safe Withdrawal Rule unless I was in my late 80’s to 90’s and needed to draw down to fund my live-in caregiver that would cost $15,000 a month (lol).
Cash can be parked in a high interest savings account that yields interest income. With the rising Bank of Canada rates, high interest savings account interest is rising as well. Interest rates are anywhere from 1-1.80% now depending on the bank institution. Although it’s not very much (and certainly won’t really beat inflation especially if you are paying tax at your marginal rate on the interest income), it’s better than nothing. Canadian Tire HISA has a high rate right now.
Related: EQ Bank Review Is the 1.50%* Interest safe?
If you have rental properties and you rent your condo out, for example, you will receive rental income. To calculate your net cash flow, don’t forget to factor in mortgage interest, maintenance, property taxes, insurance etc. Alternately, if you prefer the hands-off approach, investing in REITs (Real Estate Income Trusts) are another option to get your foot in the real estate market without having to deal with the hassles of being a landlord/landlordess.
In addition, some people have done well borrowing from their HELOC to invest and then using this to deduct the mortgage interest off their taxes (it converts mortgage interest from non-tax deductible in Canada to tax deductible). This is called the Smith Manoeuvre.
You could also get income from real estate crowdfunding in Canada.
Finally, if you have business income flowing in, for example, from a monetized (and profitable) blog. This is where it seems a lot of personal finance bloggers who have achieved financial independence and retired early succeed.
Although it’s not entirely passive as it takes writing regular posts and interactions, replying to comments etc. but it can be a fun passion-hobby-turned business. They don’t need their blog income to be financially independent, but it certainly helps, especially if the blog income provides something like $50,000 annually like it does for Retire by 40 or Go Curry Cracker.
Using capital gains as cash flow would be the case if you were to withdraw from your investment portfolio, such as the case for those interested in using the 4% Safe Withdrawal Rate for a 25-year retirement timeframe. This provides cash flow as well but with a ‘pruning’ the money tree kind of way.
Basically, things that generate cash flow mainly involve assets that can spit off sustained income for you over time. For example, trimming a large VXC ETF holding within your investment portfolio will generate capital gains.
Related: How Much Should I Have Saved by 40?
net worth is still net worth
One may argue that if you sell off your assets (illiquid or liquid) you will still have a high net worth number that can be used to generate cash flow.
However, the millionaire household net worth individuals in Vancouver would have to sell their home and move somewhere else where the home is not as expensive- I know lots of people who have done this and moved to Interior BC or to Vancouver Island, though prices are now creeping up in these much desired places too.
To protect your estate, Cashflow and Portfolios Retirement Projections is helpful to calculate.
Readers, do you find yourself obsessed with using net worth as a scorecard for yourself?
Instead of tracking our net worth, do you think we should be tracking our monthly cash flow?
GYM is a 30 something millennial interested in achieving financial freedom through disciplined saving, dividend and ETF investing, and living a minimalist lifestyle. Before you go, check out my recommendations page of financial tools I use to save and invest money. Don’t forget to subscribe for blog updates, a free dividend yield spreadsheet, and the free Young Money Bootcamp eCourse.
11 thoughts on “Why Cash Flow Is More Important Than Net Worth”
You are bang on!
I used to track my net worth before housing took off in Vancouver and then I realized it wasn’t helping me reach my financial independence goal. Before I knew it, I had a net worth of $1M but did not feel like a millionaire. I changed my approached and focused on income generating assets (anyone read Rich Dad Poor Dad?).
My focus then changed to grow my financial independence value towards $1M. I am oh so close!!!
You are correct that your home can help since you can leverage it to generate income from the loan as long as your mortgage is not strangling you … I have had an investment LOC for almost 8 years now and with interest rate going up, I am slowly paying it off now. I double the money I borrowed which significantly beat the rate I was paying in interest considering it’s tax deductible.
@Wally- Thanks for stopping by! Interesting, I am the opposite. I would like to build my net worth first and then focus on cash flow. But I can see how your method would work very well too!
Sometimes buying a house is bought as a sort of “forced” savings, but I don’t think it’s realistic to count primary residence in net worth, because it’s not liquid.
I definitely feel that my NW would be much higher if I did own and counted it, but there’s also something that feels pretty good about having it all in cash and investments.
Seven figures by 40 is amazeballs! The markets have been stagnant for a bit and I’m super impatient to make it into the next hundred thousand milestone! Been stuck in the 3s for a while now.
@The Luxe Strategist- Yes, one of my friends (who has a 7 figure mortgage, yes, that’s right) said buying housing was like forced savings for her. I know what you mean, a strong sense of empowerment knowing that your NW is in cash and investments. It feels more ‘liquid’ and free. Hey 3’s in all-investments is amazeballs! I don’t even have 3’s in my investment portfolio 😉 Hopefully by the end of this year.
Love this post (I love all your posts) I agree cash flow is the key ingredient. As you know I am using dividends to fuel my cash flow.
Thanks for this awesome post.
@Matthew- Thanks Matthew, you are the best blogger buddy (get it, Buddy?) ever! You are doing great with your dividend cash flow!
Cash flow is king. I think we should all track both cash flow and net worth. As to your point if you are house rich and cash poor it will not be easy to make ends meet.
With cash flow it gives you flexibility from saving money to spending it. If you have a healthy and diversified enough cash flow you have so many options to invest into your ideas.
I know for me I have goals for both net worth and passive cash flow. I know I focus on cash flow more from increasing rental rates to identifying different ways to grow passive income. As when I increase my cash flow I can invest more which helps me reach my net worth goal.
Thanks for your post!
@Financial Fred- Yes, exactly! They are both intertwined and both good to aim for increasing.
Good points here. I’ll admit I have been sort of net worth obsessive since I started going down this rabbit hole, though I rent and don’t own a home so my net worth is largely tied to incoming-generating assets (investments). As Luxe commented, maybe by leaving the primary residence out of the equation that also solves the unrealistically inflated net worth.
@Impersonal Finances- Yes, I’ve started to do this too, leaving the primary residence out. It’s freeing when you calculate your net worth like that. No strokes to the ego if you go that route. When your net worth is just liquid investments, I can see why you would be net worth obsessive since it’s a direct correlation of your investment and savings (and not just home equity).