Investing for capital gains or cashflows??

I am thinking hard recently as to whether to invest for capital gains or cashflows. I believe everyone should know the meaning for capital gains. Buy a stock at a certain price and then sell at a higher price at a later time. The duration to hold the stocks can be short or long depending on the amount of capital gains one desires. I have also touched on how much capital gains one should preferably aim for (for a trading mindset or long term investing mindset) in an earlier post based on my own research.

As for cashflows, I am referring to the dividends one receives for all his stock holdings in his portfolio. This question is important to ask as we are surely approaching the next bear market anytime in future. Nobody knows when. But, everybody should know the "bear will surely wake up from hibernation" sometime in future. The valuation for most if not all stocks will be send to the depths again during the next bear market. Again, nobody knows how much the extent of the next bear market in terms of duration and damage to valuations of equities globally.

I believe it is always wise to think one step ahead and make preparations for something that is certainly to come. So, this raises the question of whether one should go for capital gains or cashflows. I have heard from a friend who has invested through a few market cycles of bull and bear holding on to his same stocks which were bought many years ago. He told me that the valuation of his stocks now compared to his initial bought in valuations many years back is higher. However, the difference in valuation is not much. He does agree that it would be wiser for him to sell at the height of a bull market locking in his capital gains and buy back again during the depths of a bear market and keep repeating the same process through the few market cycles he had seen. The only problem is even as he knew about this simple possible strategy, he did not commit himself to do it and so left his stock holdings through the years to the mercy of the many market cycles.

However, one thing he commented is that he still receive good amount of dividends from his stock holdings and the total amount of dividends had increased through the years. Of course, he does reinvest his dividends and make further capital investments to buy more stocks through the years so his total amount of dividends received has been growing through the years.

So, back to the same question again. Invest for capital gains or cashflows? My answer is a consolidation of thoughts from all my earlier blog posts based on the summation of all my research so far. I do not count myself as a knowledgeable investor as knowledge is never ending and I am always learning new things about investment everyday. The answer I arrived at is that one should invest for both capital gains as well as cashflows.

Both ways of investing, for capital gains or cashflows, have their merits and shortfalls. Capital gains of a substiantial amount (at least 30% for short-term trading and 100% for longer term investing) can help to lift one's net worth in his stocks portfolio at a fast rate. However, one does not always have the good fortune to buy into a stock that can have such magnitude of capital gains (please note that I am discussing based on the Singapore stocks market; other stocks market such as the US stocks markets may have much wider swing in valuations). Even with penny stocks, it is also not a guarantee to see substantial capital gains even after one has bought into a penny stock with a popular theme or fundamentals (whatever you call it). So, investing for substiantial capital gains has a low chance of realisation. Nevertheless, one can still lower his expectations and sell any stocks at a lower capital gains as long as it is still attractive enough for the holding period in consideration. Also, selling stocks for capital gains does make sense when one is trying to escape an impending bear market. Why leave it to chance and let the valuations of one's stock holdings that has increased have the potential to drop back to the original bought in valuations or even lower?

Thus, investing for substantial capital gains though having a low strike chance, is still well worth the effort to do so to accelerate one's rate of return on his investments. The other way of investing for cashflows has it's own merits as well. Cashflows investing is a stable consistent way of deriving recurring income from one's portfolio. Cashflows income is difficult to build in the initial stages but when one's stocks portfolio size is big enough, the amount of regular dividend income one can derive is not to be looked down upon. However, when investing for cashflows, one needs to hold his dividend paying stocks for a long term to keep building and sustaining his dividend income.

The frustrating question comes when his dividend paying stocks have risen so much in valuations to allow him to have the possibility to capitalise on a substantial capital gains by selling off his regular dividend income paying stocks. 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. I believe we might have reach a simple conclusion ourselves whether the first farmer should sell or not, and if he sells, to which farmer should he sell.

For those interested to share your ideas as to what action the first farmer should take, you can drop in your thoughts under the comments for this blog post. 

Lastly, my conclusion is that one should invest both ways, for capital gains and cashflows. An analogy for this is that cashflows represents a normal car while capital gains represents a turbo engine that can be fitted to the car. The turbo engine can not be fully utlilised during the entire duration of operations of the car as it will cause the car to overheat and wear out very fast. But, if the car does not have a fitted turbo engine, it cannot achieve another quantum leap in it's maximum speed and torque. So, use both capital gains and cashflow investing to one's advantage. A basal amount of cashflows from recurring dividend income is always welcomed. In addition, some capital gains can also help to accelerate the rate of return on one's investments.

PS: Please note that this post is just a simple discussion and by no means an indepth discourse on both ways of investing. There are certainly more considerations (e.g. investor's individual personality and financial objectives to look at when investing).