Using Stocks to Invest for Cash Flow

Investing in stocks can be produce positive cash flow (passive income) when the right strategies are apply.

Master Investor
April 19, 2024

Summary:

Most people believe that the masterinvestor’s theory of cash flow investing and stock investing are incompatible.
But a knowledgeable investor understands how to use the stock market to deliberately create cash flow.
There are two methods to use the stock market to create cash flow; find out how to do each by reading on.

Master Investor stands apart from other financial education providers in part because we don't advise us on what to buy or invest in. Rather, we show all the variety of investment opportunities and explain why they are worthwhile.

Many investors may find real estate to be a decent fit, but not all investors will find real estate to be a fantastic fit. For most people, stocks may be a very sensible investment, but not for everyone. A successful investment vehicle should align with our beliefs, lifestyle, and personality, whether it be stocks, real estate, businesses, or commodities. There isn't a single investing vehicle that works for everyone.

Investing in stocks and following the masterinvestor’s cash flow investing strategy

The majority of people think that investing in stocks and the masterinvestor’s cash flow investing concept are mutually exclusive. People mistakenly believe that stocks are just a capital gains investment, which involves buying low and selling high.

For three reasons, cash flow is superior to capital gains in our instruction:

It is resilient to fluctuations and instability in the market.

It consistently puts money in our pocket—real money, not just made-up "paper wealth" like net worth.

Generally speaking, it is taxed at a lesser rate than other types of income, such as capital gains.

It follows that you might believe we're advocating against investing in stocks if we believe that equities are just for capital gains and we follow masterinvestor’s cash flow-focused investment strategy. However, we're not.

Because a knowledgeable stock investor understands how to profit from the stock market rather than only looking to make money gains.

We will learn about two strategies in this post for investing in stocks and using the masterinvestor’s approach of cash flow investing.

The first dividend method is rather straightforward. There is a significant learning curve for the second covered call method.

Investing in dividend-paying stocks for cash flow

About dividends, the NASDAQ website states this:

A dividend is essentially our portion of an owned company's profits. We are granted two fundamental rights when we invest in a company or buy shares. We have two rights: the first is the right to vote in favor of choosing the board of directors who will govern the business, and the second is the right to receive a portion of the earnings, at the board's discretion. This is disbursed as a dividend. The amount of the dividend (if any) to be paid per share will be disclosed by the board of directors together with the company's quarterly results.

We will therefore get $50 if a corporation announces a $0.50 dividend for a particular quarter and we own 100 shares.

Visit http://www.nasdaq.com/article/what-is-a-dividend- to learn more.

Therefore, investing in stocks that consistently pay dividends would increase our cash flow by adding assets to our portfolio. We can eventually have enough money from assets like these to spend however we wish, whether that be now or when we retire.

There is one qualification, though. We have no control over dividends because they are entirely at the board of directors' discretion. Additionally, we are powerless over the firm we purchase stock in, therefore we are unable to affect its quarterly success.

Hence, although dividend-paying stocks are a cash flow investment, it requires little financial acumen. Thus, there are also little returns.

Covered call investing as a cash flow approach

A high degree of financial literacy is necessary for the covered call approach. Nevertheless, this also means that there is a great chance of profit. Things are about to become insane. But it's really exciting once we figure it out! Let's now discuss how cash flows from a covered call (a stock option) work.

An agreement to sell a specific stock until a predetermined date at a predetermined price is known as a stock option. He gets paid a premium in exchange for this assurance.

This premium is dependent on both the passage of time and the movement of the stock price.

Since stock options might be complicated, let's use real estate as an example.

Assume for the moment that we are a home owner and landlord. A family is identified to purchase the house, but they are unwilling to do it right now. Rather, they choose to rent the house for three years, with the opportunity to buy it at the conclusion of the lease for a predetermined sum.

We are making money on the passage of time (rent) while we wait for the lease to end.

No matter what occurs, as the owner of a lease-to-own home, we will profit.

It makes no difference if the house's value rises or falls. The family received a good bargain if the house's value rises above the agreed-upon amount, but since we fixed the price, we still got what we wanted.

At the end of the lease, we will probably be the one to keep the house if its value decreases and the family decides not to purchase it.

We can now leave and take up the house lease-to-own once more. Wash again. Repeat.

We now have an understanding of the overall operation of a stock option, albeit it is not quite the same (we do not receive payments during the duration of the option contract):

Stock XYZ is yours.
We sell an option to purchase. Stock XYZ at a predetermined price after a predetermined period of time.
We receive the option premium when the term expires.
Either we keep ownership of Stock XYZ or we sell it at the agreed-upon price.
Repeat.

Let's go from examples involving real estate to practical ways we can apply this cash-flow method to really profit from options trading in the markets. This is particularly helpful in challenging markets where buy-and-hold investors are experiencing extreme ups and downs.

Let's explain what a covered call option is:

An option is a commitment made by someone to sell a specific stock until a predetermined date at a predetermined price.

He or she gets paid a premium in exchange for this assurance. This premium is dependent on both the passage of time and the movement of the stock price.

In our experience as a teacher, many individuals find it difficult to understand the concepts of time decay and cash flow in the stock market. I am aware that it took some time for me to see the light. We therefore made a minor exchange a few years ago only for educational purposes. Just as many real estate investors maintain their rental property regardless of price variations, we decided to hold a stock for an extended period of time despite swings in its value.

Let’s say we purchased an Exchange Traded Fund (ETF) and held it for a year in order to demonstrate to my students the parallels between real estate investors collecting rent and stock investors selling options. We don't typically hold stocks for that long, much less purchase something that is declining. However, we set out to demonstrate that a stock that is losing value can still produce revenue, just as a property that is losing value can still produce rent. This is a real set of extremely trades that investors executed in the subprime crisis.

Initially, someone one purchased 500 shares of the XYZ (SPY), an exchange-traded fund that replicates the performance of the S&P 500. Given that the XYZ (SPY) only replicates the S&P 500, this was crucial. Whatever happened, they were going to hold it for a year. They kept a tight eye on it after we bought it to check if it was moving sideways, upwards, or downwards.

They were in the position of being the option seller rather than the option buyer because they are the owner of the shares.

Investor purchased 500 shares of the SPY exchange-traded fund and subsequently sold five contracts for one-month call options at a $2.15 premium.

The investor informed the buyer that investor may purchase the spy at any moment before the expiration date for $154, which was more than investor had paid for the spy.

There are now three possible routes for the stock to go:

Since investor purchased it at a lesser price, investor would have profited if the stock increased and investor desired to buy at $154.
The option would have expired worthless and we would have kept my $2.15 (multiplied by 500) premium in cash flow if the stock had continued to move sideways and stayed below $154. This is comparable to a residence whose worth doesn't change. That rent would still be my source of income.
The option would expire worthless and we would keep my $2.15 premium (multiplied by 500) if the stock fell.

As we can see, investor has created a situation in which he or she would always be able to make money from an asset that the investor had bought. This seemed like a very appealing approach for all to make our passive income. After purchasing 500 shares, the investor sold the options. That equates to five 100 share one-month contracts at a premium of $2.15 apiece. If we do the math, we will find that the investor made $1,075 in revenue and deducted the brokerage fee to have a net income of $1,061.

Remember the Cash Flow Circle

Make sure we pick the right side of the cash flow circle in order to build true wealth (total freedom).

This demonstrates how to own stock assets and make money off of them.

Investor spent a whole year selling options on XYZ shares month after month, despite the stock's decline in value. Why? For all intents and purposes, we are no different from a real estate investor who experiences a temporary fall in the value of his rental property. He or she gets the rent every month, and we get our money from options every month too. Even as we both wait for the assets' underlying worth to increase, this income keeps coming in. We get to keep the stock as long as time decay generates revenue.

When an underlying asset, such as a stock or home, can lose value but the cash flow is relatively stable, that is considered true cash-flow investing.

As we previously stated, most individuals believe that the masterinvestor’s concept of investing for cash flow and stock investment are mutually exclusive.

Yes, if we are thinking about the typical investor's approach to stocks, which is to purchase, hold, and pray. On the other hand, a well-informed inside investor understands the benefits of cash flow investing and how to do so.