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Cash Flow = Wealth

Here in the U.S. we tend to express wealth in terms of net worth: “Bill Gates owns $X Billion.” I’ve read, however, that in other parts of the world, people express wealth in terms of income: “Bill gates is worth X [local currency units] per year.” (Can any non-US readers confirm that this actually does happen, by the way?)

This cash-flow-centric way of looking at wealth makes a lot of sense to me. After all, isn’t the whole goal of personal finance to ensure that our cash flow will exceed our expenses throughout our lives? Isn’t that precisely what we’re trying to achieve when we take money and sock it away during our cash-flow-positive years and save it for those years that we expect to be cash-flow-negative?

Benefits of Looking at Cash Flow

It keeps your focus in the right place: When we focus entirely on net worth, we develop an unhealthy tendency to monitor the value of our investments far more frequently than necessary. And I suspect that the more a person obsesses over her current account value, the more likely she is to panic and sell after a market decline.

In contrast, if that same investor were to focus instead on her cash flow, she might see that:

  • She’s earning more than she spends,
  • She’s protecting her income (by owning life insurance & disability insurance), and
  • She’s putting away money for the period in her life when she expects not to naturally be cash-flow-positive.

Maybe things don’t look so bad after all. Maybe there’s no need to panic. 🙂

It makes it easy to see whether or not you’re saving enough: Many investors don’t even know where to start in terms of figuring out how much they need to invest each month in order to meet their goals. Of course, this is no surprise, given that many investors are similarly clueless about how much money they’ll need in order to retire (if that is, in fact, their goal).

Once we put the focus where it belongs–cash flow–we can start figuring out how much money a person will need in order to retire. That is, once you know that you’re going to need $x per year in order to pay your bills, it’s relatively easy to figure out how much you’ll need to have accumulated in investments in order to generate that level of income.

What do you think?

How do you most frequently think of (financial) wealth? Why?

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  1. We used to understand this much better, I think. Just look at the focus in Jane Austen or other dusty novels about a gentleman’s annual income.

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