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1 question to transform your finances

Talking to Bankrate’s senior financial analyst Greg McBride about investing in gold one day, I asked him why he thought gold was, in general, not a great place for normal people to put their money. His reply was something like, “It’s metal. It doesn’t produce cash flows.”

Later I thought, why not apply that to everything?

See, stocks and other good investments produce cash flows: money you get just for owning that investment. For stocks, that comes in the form of your share of all the profits that company makes, paid out either as dividend checks, or as appreciation of your stock as the price increases. For bonds, it comes in the form of coupon payments that a company makes to you in exchange for lending them money for their business.

But any way they come, cash flows are awesome. At its best, a good portfolio of stocks and bonds is like a magical box that fills up with money every few months. That you just get to have. Without doing any work at all.

Eventually, if you build a box that’s big enough, you can cover all your living expenses, and never have to have to worry about getting laid off, or even working again if you don’t feel like it. If someone offered to sell you one of those, you’d probably buy it, right? But instead, most people spend their money on things that don’t produce cash flows — new iPhones [3], clothes, sneakers, restaurant food, etc.

To me, the most valuable thing I can have is freedom to spend my time as I choose, and financial independence definitely makes that easier. So, as far as my own personal finances go, I’m trying out a new test for whether I should buy something: Does it produce cash flows?

That’s especially true for things you usually have to borrow money to buy, such as a college degree. For most people, their main source of cash flows is a paycheck from their employer, so spending money on education or a professional certification that will get them a better job does produce cash flows. Similarly, if having the ability to travel a little farther to work could mean a higher-paying job, buying a basic car can help you produce cash flows, which may make taking out a small car loan worth it. Or, if you’re the creative or entrepreneurial type, borrowing money to create a business or intellectual property that generates royalties can also pass the test.

Obviously, in the real world, you’re always going to have to spend some money to maintain a standard of living that doesn’t make you miserable. For instance, taking my wife out to dinner for our anniversary is unavoidable; if I want to have a good marriage, and I do, then it’s money I have to spend. But when considering the universe of possible things to buy that I don’t necessarily need, I’m going to try and stick with things that produce cash flows from now on.

What do you think? Is there a specific litmus test you use before buying something?

(photos, from top to bottom: Flickr users skipjack 2000, nikochan and Håkan Dahlström)

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