In business, there are two ways to improve the bottom line, either by 1) putting your assets to more productive use to improve the inflow of income or 2) reducing the outflow of expenses. In investing, to improve cash flow, you can either 1) find investments with the better returns for the cash you already have or 2) reduce your expenses to free up more cash for your current investments.
Like Warren Buffett, we’ve long been proponents of cash flow investing, investing in assets that provide a periodic distribution instead of buying and holding and hoping the assets appreciate for resale in the future. So why is investing for cash flow important? Buffett said it best in a 2013 shareholder meeting, “The ideal business is one that generates very high returns on capital and can invest that capital back into the business at equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the next year earns 20% of $120 million and so forth.” Let’s take Warren Buffett’s example one step further. In the third year, let’s imagine the business reducing its expenses and improving its profits to 30%. So instead of earning 20% of $120 million, it will earn 30% of $120 million and so forth. And that is our focus in this article, how to reduce your personal and business expenses to free more cash for your investments so that you can improve your annual cash flow that can be rolled back into more cash flow producing investments.
To reduce expenses to improve your investing cash flow, it’s not a bad idea to look to corporate america for guidance. In other words, think like a CEO. The Great Recession didn’t just hit individuals, it also affected American companies as well. As investors, we can learn a lot from how execs at the best of these companies responded by cutting expenses and returned their businesses to record profitability in little time. Clark, Kim, “To Improve Your Cash Flow, Think Like a CEO,” time.com/money
In 2008, for example, Wal-Mart execs knew they had to continue cutting prices to keep financially strapped customers coming in the door. But how could they cut prices AND improve profitability? To do so without hurting the bottom line, execs knew they had to cut expenses. Some of the measures they took included suspending a stock buyback program and reduced spending on new supercenters, focusing instead on remodeling existing stores. The result? Wal-Mart revenue kept growing during the financial crisis, and its market share has increased in basic goods, such as groceries.
Here’s what you can learn from Wal-Mart and other corporations. Treat your personal finances like a business and ike any sound business, you should know what your spending priorities are and where you have room to cut. Here’s how you can apply these principles to your personal finances and free up more cash for your investments and prosper.
Reallocate Your Outflow
Just as company executives reallocate assets that fit the company’s business cycle, so should you. Take your savings rate. If you follow conventional wisdom, which suggests you should save 10% or so a year for retirement throughout your career, you can improve your cash flow immediately by re-allocating from what you set aside to your 401(k) to more productive cash flowing investments. So, reallocating half of that 10% instantly frees up more cash for real estate investing.
Cut Out Non-Essential Expenses
Easier said than done right? What is a non-essential expense? It can be a matter of perspective in a household. Your wife’s gym membership may be non-essential to you but vital to her. It’s all about a meeting of the minds and sitting down as a family, or if you fly solo, sitting down with yourself and assessing the non-essential expenses that you can cut out immediately to free up cash for investing.
Lower Your Operating Costs
Another way corporate America improves its cash flow is by reducing its borrowing costs. If you haven’t already, take a hard look at refinancing your mortgage(s). Although you’ve missed out on the interest rate bottom, they’re still historically low.
The savings can be substantial, particularly if you shorten the term of your loan. Say you refinance a 30-year $250,000 mortgage that you took out in 2007 when rates were about 6.35%, and roll the remaining debt into a 15-year loan at 3.25%. You’d have roughly the same monthly payment, but you’d save nearly $160,000 in interest and retire the debt nine years sooner. That would free more cash for investments.
You can apply the same strategy to other higher-rate debt like credit card debt and student loan debt. Refinancing that debt with a home-equity line of credit at lower interest rates will drastically lower your monthly payments, freeing up more cash for your cash flow investments.
Although we agree with the conventional approach to improving investment cash flow by finding more productive investments like real estate, there’s another strategy often overlooked for accomplishing the same feat, and that’s to reduce your personal and business expenses to free up more cash for investing. And here at Four Peaks Capital, there is no better sector for investing that additional cash than in the mobile home sector where you’ll be able to grow that cash in a recession-proof alternative investment with above-market returns.