Financial Education: Know the Difference — Cash on Cash Return vs Return on Investment

May 3, 2022

Imust confess. To this day, I still have a hard time walking into a Walmart , any Walmart— for a few different reasons. One of them is knowing that most of these greeters don’t ‘choose’ to work. They still have to work and most of them are seniors. In the rare times that I do, for some weird reason, I have Warren Buffett talking in my ear: “if you don’t find a way to make money while you sleep, you will work until the day you die.” Truthfully, I don’t have any qualms about the latter part as long as I love doing what I love every single day. Even if it’s considered work.

Learning how to invest and financial education has been an incredibly fun and rewarding journey so far. And I’m still learning everyday. It’s almost as if the more I learn, the less I know. And for a while now, that’s ok. I’m no longer worried about not getting 100% at a test and getting scolded. Or, worse yet, getting questioned on how much effort I’ve put into my work. I know that , if I’ve given what I want to do 100% of everything I got right now, I’m ok with the outcome — whatever it may be. If the outcome is not ideal, it simply means that I need an adjustment or improvement somewhere. In mindset, in knowledge level or in my skill level.

What does that have anything to do with this topic, you ask? Simple. And here’s the thought process:

• Most of us have the tendency to work harder when we want ‘more’. More money to be specifically.
• Investing is learning how money works for itself.
• Many people and ‘investors’ (I will use that term loosely here), once they acquire a property, it’s like set and forget. It’s likely one of the worse things to do as an educated investor.
• The calculations of ‘returns’ on investment deals is an important process. And the numbers represents how hard our money is working for us.

If we are willing to work hard, why wouldn’t we make sure our money works harder than us?

The answer to this question, as I’ve witnessed over the years, has separated people who just added long-term wealth (through inflation mostly) and people who achieve sustainable financial freedom.

Many ‘investors’ and sales people in the financial planning industries seem to use these terms incorrectly and interchangeably. Understanding the difference between the two terms have helped me in making buying and selling decisions of real estate investment deals more effectively and efficiently. After all, it’s all about making sure our money is working hard(er) for us so we can free up more time and energy (and money) to pursue the things we really want to do.

What is Cash on Cash Return (CoC)

Dictionary.com defines cash-on-cash return as…wait, wait, wait! Don’t go yet. I’m just kidding! Like a Best Man’s speech that nobody wants to listen to, I’m not about to take that approach…yet. However, acknowledging that I’t know everything, I may have borrow some definitions from time to time to prove a point.

I will say this though: my favourite ‘dictionary’ these days is www.Investopedia.com when I learn a new term related to investing or money. So, guess what, Investopedia defines “A cash-on-cash return [as] a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property.” It would be good to note that this refers to pre-tax income.

However, the way I learned it is simply this: the CoC is basically like the interest rate you earn. For example: if the bank is promising you 2% a year (year right 😅…) on your money in a savings account. Your CoC is 2%. Of course, if we were to get a bit more technical, then this typically would refer to simple interest.

As a result, CoC is commonly used in any sort of income properties — single family, multi-unit residential, commercial, serviced accommodations, etc. In addition, many private lending deals are dealt in simple interest so the interest rate offered by the lender (or borrower) is a directly CoC return — not counting any additional fees the lenders may impose.

CoC is a straightforward and simple measuring stick for us to know how hard our money is working for us on an annual basis. This really should serve as an indicator for investors who understands fundamentally how to leverage real estate as an investment tool. When the CoC goes down (and it typically does) to a certain point, it may be time to ‘trade up’. At this point, there’s usually some equity built up as well.

What is Return on Investment (ROI)

On the other hand, ROI is a way to measure the overall investment performance when there’s a clear start and a clear end. To compare apples to apples and borrowing Investopedia’s definition: Return on investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments.

As a result, ROI is typically tied directly with strategies like Flips and Lease Options. These strategies are known to have clear start and end dates.

Just like not all deals and not all strategies are created equally, these two terms also aren’t. They exist for a reason. To me, the reason is to support us in making better and faster decisions when searching for and comparing deals at hand.

The lesson here remains: real estate is just our vehicle in investing. The goal is to create better financial resources and blueprints for ourselves, and hopefully generations to come. Making sure our money is working hard for us at all time is, in my opinion, the highest level of the art of investing.

If you’re intrigued by this article, I would also suggest a topic for you to dig deeper into also: the velocity of money. You can read up on it or watch videos.

Tomy dedicated readers, I thank you for your support and feedback. If this is the first time you’re reading one of my publications, I hope you’ve enjoyed it and learned a thing or two.

For those of you who prefer watching videos, here is the YouTube channel where some of my work (very raw) has been shared.

(Written at home in Edmonton, AB)