Access Wealth Strategies

This post is a continuation of our discussion regarding consistent 10% passive cash flow (Part 1).

We’ve already discussed that many investors want to turn their nest egg into a predictable stream of cash flow that can replace or supplement their active income.

So why is it so difficult for investors to achieve a satisfactory double digit return on their capital (after management expenses and preferably after taxes also) if they do NOT wish to take an active role in running a business?

Remember, all investments are ultimately tied to some underlying business which tries to generate revenue that exceeds the cost of capital invested.

We’ve all heard the overwhelming statistics of business failures, so a truly successful and profitable business is not something to be taken for granted.  It is truly a remarkable feat for a business to take on investor capital, pay investors a good yield for their money, and still remain a consistently profitable business.

Active vs. Passive Investing – What’s the Difference?

A savvy entrepreneur can build a successful business with very little start-up capital and reap the highest reward for that investment.  However, this requires talent, sweat equity and favorable market conditions, etc.

Now imagine a passive investor who does not want to be working in the business or on the business.  The investor would need to hire someone else to do the management work required and pay them reasonable compensation. In this case the passive investor would get a lower return on his investment in the business than the entrepreneur who works in or on the business.

How about having yet another layer of indirection? Perhaps some “fund manager” that chooses businesses to invest in for you?  Or, buying stocks (ownership) or bonds (debt) in the business on a publicly traded market where pricing for these “paper” derivatives of the business can be somewhat independent of how the business is actually performing?

You get the idea – chances are investors in “business derivatives” don’t do as well or don’t have as much visibility into the assets they indirectly own.  All the layers of management will have to be paid off before the investor gets his return. As you all know by now, Wall Street is notorious for charging high fees regardless of the success (or most likely failure) of your investment.

Generally speaking, investment return decreases as more layers of “management” are added between the investor and the underlying asset (business).  The investor also has less control over the underlying asset the further removed he is from the asset.

So, what does this mean for the passive investor’s quest to achieve consistent cash flow?

• Get as close to the underlying asset/business as possible without working in the business.  Have a straight line of communication to the manager of your asset.
• Often, it is better for management to have vested interest in the asset and not just a “hired hand”.  In other words, make your management team your partner, not your employee.
• Invest in distressed assets and partner with someone who knows how to “improve” the assets and realize their full potential, or be a lending partner (i.e. become a hard money lender).
• Consider investing in a proven business system (i.e. a franchise) to short cut the learning curve and outsource most of the management gradually.
• Allow the business to “incubate” before reaping the reward of consistent cash flow.  You may need to invest more time and energy in the business during the incubation period.
• Ladder into fixed income type assets with different maturity dates.
• Invest in self-renewing assets (e.g. orchards, forests, producing oil wells, etc.) that can produce income for years after an initial setup period.

We will discuss some examples in more detail in Part 3 of this series.

Meanwhile, please share your thoughts, questions, and opinions by commenting below.ve

Most investors I’ve been talking to want to turn their net worth (or “nest egg”) into monthly checks that replace their active income (from a job or business) and cover their living expenses.

If you are an investor (and most people are forced to become passive investors at least in their retirement accounts), chances are you want a consistent and predictable cash flow or passive income stream that is at least 10% (annualized yield) of the lump sum you have to invest.

So if you have $1 million to invest, you may want to generate a 10% return or $100,000 cash flow per year.

The interest in safe and secure double-digit cash flow increases as people approach retirement. They don’t want to reduce their standard of living but they do want to reduce their active working hours, or have the option to take time off work to enjoy life.

Why is a simple, predictable return of 10% per year so difficult to achieve passively?

Here are some of my thoughts:

• While you could build a successful business that produces 10% or more annual cash flow, it would require your active engagement (at least initially) and therefore would not be a passive investment from the start.
• The business cycle is “lumpy” and therefore it is unrealistic to count on a consistent cash flow for a long period of time.
• The law of supply and demand in the free capital markets will cause an investment that yields double-digit returns consistently to be bid up so high that the yield will eventually fall below 10%.

I will expand upon these ideas in future posts.

Thus, the mythical 10% per year passive cash flow will remain just a dream for most passive investors.

What do you think? What kind of passive investments can you think of that produce 10% or more annualized cash flow consistently right from the start?  Please add your comment and let me know.