2 Ways to Cash Flow with the Stock Market
One of the things that makes the Rich Dad Poor Dad Daily so different from other sources of financial education is we don’t tell you what to buy or what to invest in. Instead we teach why an opportunity is good and we show you how many different things there are to invest in.
Real estate may be a good fit for many investors but it’s not a great fit for all investors. Stocks may make a lot of sense to most people, but certainly not all. A good investment vehicle (stocks, real estate, business, commodities) needs to fit with your lifestyle, your personality, and your philosophies. There is no investment vehicle that is one-size-fits-all.
Most people believe that stock investing is at odds with the Rich Dad philosophy of investing for cash flow. The reason people believe this is because they think stocks are simply buying low and selling high. An educated stock investor knows how to cash flow with the stock market, not just invest for capital gains.
Cash flow is better than capital gains for three reasons:
- It is resilient from market swings and market chaos.
- It brings money into your pocket on a regular basis (not imaginary “paper wealth” such as net worth).
- It is generally taxed at a lower rate.
I’ll go over two ways that you can invest in stocks and follow the Rich Dad philosophy of cash flow but first, let me explain the two types of investors…
Rich dad said, “A fundamental investor reduces risk as he or she seeks value and growth by looking at the financials of the company.” The most important consideration for selecting a good stock for investment is the future earnings potential of the company.
A fundamental investor carefully reviews the financial statements of any company before investing in it. The fundamental investor also takes into account the outlook for the economy as a whole as well as the specific industry in which the company is involved. The direction of interest rates is also a very important factor in fundamental analysis.
The technical investor tends to buy on price and market sentiment—just like a shopper shops for sales and discounted items. The technical investor studies the pattern of the history of the company’s stock price. A true technical investor is not concerned with the internal operations of a company as a fundamental investor would be. The primary indicators the technical investor is concerned with are the mood of the market and the price of the stock.
The difference between the two investment styles is dramatic. The fundamental investor analyzes the company from its financial statements to assess the company’s strength and potential for future success. In addition, the fundamental investor tracks the economy and the industry of the company. Warren Buffett has been acknowledged as one of the best fundamental investors.
While both types of investors invest from the facts, they find their facts from different sources of data. Also, both types of investors require different skills and a different vocabulary. The frightening thing is that most of today’s investors are investing without either technical or fundamental investor skills.
Earlier, I mentioned that a lot of people believe that investing in the stock market is at odds with the Rich Dad philosophy of investing for cash flow.
Here are two way to cash flow with the stock market.
The NASDAQ website says this about dividends:
At its core, a dividend is your share in the profits of a company you own. In return for purchasing stock, or investing in, a company you are given two basic rights. First, you have the right to participate in electing a board of directors to run the company, and second you have the right to be paid a share of the company’s profits… thus, if a company declares a $0.50 dividend for a given quarter and you own 100 shares, you will receive $50.
So if you were to buy stocks that pay regular dividends, then you are purchasing assets that add to your cash flow. With enough assets like this, you can eventually have the income to do whatever you like, right now or in retirement.
The covered call strategy is not for the uneducated. This is going to get a bit crazy. But once you get it, it’s very exciting! Now, let’s explain cash flowing a covered call (a stock option):
A stock option is a promise by someone to sell a certain stock at an agreed-upon price until a certain date. In return for this promise, he receives a premium as income. This premium is not just based on the movement of the stock price, but on the movement of time.
Let’s have Rich Dad Advisor on stocks, Andy Tanner, explain a covered call option:
To show my students the similarities between stock investors selling options and real estate investors collecting rent, I bought an Exchange Traded Fund (ETF) and held it for a year…
My first step was to buy 500 shares in an exchange-traded fund called the Spyder Trust (SPY), which mimics the S&P 500. This was very important because the SPY simply mimics the S&P 500. I was going to hold it for a year, come what may. After buying it, I watched it closely to see if it was going up, down, or sideways.
Since I owned the shares, I was positioned to be the seller of an option instead of the option buyer.
After buying 500 shares of the SPY exchange traded fund, I then sold five, one-month call option contracts on SPY at a premium of $2.15. I promised the buyer that he could buy the Spy for $154 (which was more than I paid for the SPY) at any time before the expiration date.
The stock could now go in one of three directions:
- If the stock went up and he wanted to buy at $154, I would have made money since I bought it at a lower price.
- If the stock went sideways and stayed below $154, the option would expire worthless, and I would have kept my $2.15 (multiplied by 500) premium in cash flow. This is just like a house where the value remains the same. I would still be getting that rent as income.
If the stock went down, the option would expire worthless, and I would keep my $2.15 premium (multiplied by 500).
Andy set up a scenario where no matter what happened, he would generate income from an asset he’d purchased. Even though the stock was falling in value, he continued to sell options on my shares of the SPY month in and month out for a whole year.
Because he’s not much different than a real estate investor who sees the value of his rental house decline for a season. The real estate investor is receiving his rent each month and Andy is also receiving my income every month from options.
This shows you how to own stock assets and generate an income from them.
True cash-flow investing is when the underlying asset, whether it’s a house or a stock, can go down but cash flow stays fairly consistent.
Editor, Rich Dad Poor Dad Daily