Wealthy or rich?

This is a follow up post from the last post. The question goes like this:-

Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.


What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose.

Should the first farmer sell his goose, and to the second or third farmer does he sell should he decide to sell?

As I mentioned before, everyone is entitled to their own choice in making decisions, especially investment decisions depending on their personality and financial objectives. However, I believe there is an objective way of looking at things, doing things that really make good sense.

The first farmer in my humble opinion should sell his goose to the third farmer. If no farmers come along to offer him a higher price for his asset (the goose) which is currently generating recurring cashflow for him, he should stick to his asset since it is giving him a consistent 10% yield annually (assuming his yield can be always adjusted to account for inflation maintaining a consistent 10% annual yield). The second farmer offered him a capital gain potential which is much lower than the third farmer.

The third farmer's offer of 100% potential capital gain for the first farmer is attractive enough for him to let go of his cashflow generating asset. By doing so, he will now receive $72 for his goose. Assuming the price of a goose has not increased yet, the first farmer should go back to the market and buy back two geese now with $72. With two gesse in his hand, he can now receive more recurring cashflows, in fact double the amount of recurring cashflows he once received with only one goose.

Of course, one may question is there likely to have such a person as the third farmer who will offer a potential capital gain of 100% to the first farmer. In life, anything can happen. All kinds of people exist. Some are shrewd, some are impulsive, some are careful, some are careless, some are calculative and yet some are generous. So, such a third farmer character may not always come along. The idea here is 'may not' but does not mean 'do not'. There is still a probability for one to capitalise on a substantial capital gain (in magnitude of at least 100%) just that this scenario does not happen easily.

When this happens for the farmer's case, he should grab the chance to realise his capital gains. And, the important thing here is after he has got his capital gains, he went back to buy two geese with his money. For the first farmer, he saw the importance of recurring cashflow income in his business of selling eggs. So, he places his priority on building his cashflow generating assets (his geese). Capital gains is but only an icing on the cake, good to have only if it is really good to have. In his case, the capital gains has allowed him to further his acquiring of more cashflow generating assets.

So, come to the conclusion of the matter. Invest for both cashflows and capital gains. The foundation of investment is on building up and generating good amount of recurring cashflows. To accelerate this purpose, capital gains on any assets must be reinvested to acquire more cashflow generating assets. Then, this makes some good sense to go for capital gains in addition to just collecting cashflows alone from investments.

The problem with many is that one can be blinded by immediate gratification of a capital gains and tip the scale in favour of always going for capital gains in investments. This brings me to the title of this post, "Wealthy or rich?".

To be wealthy, one has to acquire cashflow generating assets. It does not matter how much in total value one's assets is. It is not the total value of assets that matter, but the yield on the assets one is receiving that matters. A person may only have for example $500,000 in total value for all his assets. However, if he is receiving $250,000 annually from all his cashflow generating assets, he is getting a yield of 50% (this is just for illustration - it is not easy to get such high yields).

On the other hand, one who is rich has a lot of money, but no cashflow generating assets. For example, one can be a millionaire with $1,000,000. But he may not be receiving any cashflows at all if all his money is held as money. So, effectively, his yield is 0% annually. No cash flows into his pocket since he does not own any cashflow generating assets. But, cash is constantly flowing out of his pocket. He has to use his money somehow if not for buying luxury items, at least for minimal survival needs.

For such a person, he is rich but not wealthy. The problem with him is that his money will be drained out sooner or later through his expenses. Another invisible force that is slowly draining away his money is inflation. Due to the US free printing of currency, the value of currency will be eroded. More money is flooding the market as time goes by. So, even if this person does not use a single cent of his $1,000,000, the same $1,000,000 will not be worth this amount some years down the road because one has to use more money to buy the same goods and services in future. That is why prices of houses has increased through the years. It is not the houses that have increased in value, but our money that has decreased in it's value due to printing of currency and inflation. We have to use more money to buy the same type of house in future.

So, be wealthy or rich? To be wealthy means deriving good amounts of recurring cashflows from cashflow generating assets. To be rich means having a lot of money, pure money that can potentially erode in value until zero with the passing of time.