Net worth and cash flow are not the same thing. But which is more important?
Oftentimes you’ll hear notable businessmen and investors be introduced with their net worth, like a tagline or a title. And while amassing a large net worth is impressive and does give credibility to those who are able to do so, it might not be the best method to measure affluence.
Let me explain.
Why People Get Net Worth Wrong
Net worths are understandably important. High net worths mean people have large amounts of wealth. In fact, that’s how the Oxford Dictionary defines net worth - “the total wealth of an individual, company, or household, taking account of all financial assets and liabilities.” In other words, net worth is assets minus liabilities. So if Adam has a house worth $500,000, and his mortgage is $350,000, then his net worth is $150,000.
But here’s where many people go wrong. They have the false belief that the total value of their home counts towards their net worth, regardless of the debt they owe on it. This means that Adam would think his net worth is $500,000, when it’s really $150,000.
But even if Adam’s net worth was $500,000, why does it matter? It’s not like he’s holding $500,000 in his hands. Adam’s net worth comes from what he thinks his house is worth. He determines the value based on what other similar properties in the area have recently sold for in the past. But Adam will never be able to realize this “gain” until he sells his property. And any equity he does have in the property - meaning any positive difference between the value of the property and the debt he owes on it - is illiquid.
This scenario reflects the notion that the way most people calculate their net worth is an estimate at best, an illusion at worst.
Cash Flow As a Superior Measurement
Any healthy business has healthy levels of cash flow. Cash flow is defined by the Oxford Dictionary “the total amount of money being transferred into and out of a business.” Robert Kiyosaki, author of Rich Dad Poor Dad, defines cash flow as “passive income that comes through business or investments.”
Cash flow from investments produced without you having to actively work for it to generate it can be considered “passive income.” Passive income (aka cash flow) is arguably the best way to measure your financial well-being, especially since it can be measured in the present.
What’s The Difference Between Cash Flow and Net Worth?
Cash flow is liquid and reliable. It can be easily measured and it’s predictable. Net worth is illiquid and it can be harder to measure. Cash flow is what is left over after you pay your expenses.
Many say cash is king, but Kim Kiyosaki would say - “Cash flow is queen!”
Benefits of Cash Flow
There are many advantages to having cash flow.
Expenses Covered: The more cash flow you have, the more money you have to spend on your necessities, luxuries, and savings. Someone with more cash flow is better off than someone with a high net worth because they don’t have to rely on debt as much, and they can take more calculated risks and take advantage of opportunities as they come.
Liquidity: Cash flow is money that is in your pocket. Net worth doesn’t put money in your pocket. If you ever need easy access to cash, cash flow will prove vital. If a high net-worth individual like Adam (from earlier) needs to sell their home to access capital, then how financially well off are they?
Net Worth Volatility: Your net worth can go up or down the same way the value of your home can. Even if it increases, this doesn’t increase the amount of money you have access to on short notice. Cash flow is usually more reliable, and it’s physical money in your possession.
Multiple Streams of Income
Did you know that the average millionaire has seven different income streams (The College Investor)?
Some common income streams include earned income from a job, a spouse’s income, investments, rental property, and a side hustle. Diversifying your income streams is key to building and preserving wealth long term.
According to Capital One, the three main types of income are “earned, passive, and portfolio.” Earned income encompasses salary, tips, bonuses, and commissions. Passive income comes from rental income from real estate, royalties, or limited partnerships (like in an apartment syndication). Capital gains, interest, and dividends are all types of portfolio income.
The bottom line is that diversifying your streams of income is essential. But when you’re starting out and beginning to build wealth, the smartest investors we know emphasize this: Step one is buying and investing in income-producing assets. Then you can worry about your net worth.
This is advice we are and plan to continue taking.