Income refers to money a person or business entity receives to provide a service or when making an investment. Passive income and active income are two categories of income. No matter how you make an income, the money you make will fall into two categories: passive income, or active income. This article will help you understand the difference between these two types of income.
Passive Income
Passive income is generally earned from an income-producing asset that the investor is not actively involved with. Often, that asset was purchased with savings from active income sources, like wages, salaries, or other compensation. Passive income is earned with little or no effort, and individuals and companies often make it regularly, such as an investment or peer-to-peer (P2P) lending. The Internal Revenue Service (IRS) distinguishes it from earned income as money earned from an entity with which you have no direct involvement.
Passive income can provide significant security if it provides steady cash flow because it’s not connected to your time. If it’s not enough to quit your day job, it’s still nice to have an additional income source to supplement what you earn from working. If an individual’s passive income is big enough, it can free up their time to do other things besides work. And although it may be risky when establishing the mechanism for passive income, it also offers increasing levels of financial security.
One example of passive income is the profit realized from a rental property owned by investors who are not actively involved in managing it. Another example is a dividend-producing stock that pays an annual percentage. While an investor must purchase the stock to realize the passive income, no other
Examples Of Passive Income
1. Interest Earned From Investments
Earning interest on investments is the original, and most powerful form of passive income. In fact, this is why contributing to a retirement account is so important throughout your career. If you can build up enough money in investments, you can live off the interest for the rest of your life. For example, if you were to invest consistently, and aggressively enough to build up $5 million in your retirement portfolio, then your annual income if you lived off the interest, alone would be $500,000 at a 10% return. That’s a bigger income than most people ever dream about. And you wouldn’t have to put in an ounce of extra effort in order to earn it.
2. Affiliate Income
Affiliate income, it’s basically just money you receive as a referral commission when users click through a specially-coded link on your website and make a purchase. Thousands of companies offer affiliate commissions for their products or services, so the opportunities are endless here. This is also one of the best ways to make money from a blog. If you build a large blog audience online and monetize your site with relevant affiliate links, you can generate large amounts of affiliate income.
3. Display Advertising
Another form of passive income is display advertising. This is along the same lines as affiliate income, because you need to have a website or blog that gets a large amount of monthly traffic in order to earn money this way. That said, if you put in the work to build a website that gets tens of thousands or even hundreds of thousands of monthly pageviews, then you could make a great passive living with display ads.
4. Rental Income
If you have the money to buy a rental property, you could spend years pulling in monthly rent checks as passive income. Now, this is one of the higher-risk forms of passive income, because it requires a large upfront investment, and if you can’t find a tenant to pay you rent, then you won’t make any money. The other thing about rental income is that you have to maintain the property; which, at times, can make rental income feel more like active income.
5. Online Course Sales And Info Products
Online Course sales and info products are the big winners for online passive income. The key to this, once again, is to build a large online audience which can take years. But, if you have an audience, and you launch a course that teaches a valuable skill, then you could easily make tens of thousands of dollars per month. Many people make six figures or even seven figures a year from this passive income stream alone.
Pros & Cons of Passive Income
THE PROS
The main benefits of creating new passive income streams include:
- It diversifies your income.
- It compounds growth potential.
- It accelerates your path to financial freedom.
- Passive income allows you to earn money with minimal effort.
THE CONS
- Significant upfront time requirements.
- It has large upfront capital requirements.
- It isn’t always possible to outsource everything.
What Is Active Income?
Your job earns active income in the form of a salary, hourly wage, tips, and commissions. Active income means you are performing tasks related to your job or career and getting paid for it. Active income takes up your time. Active income is money received for performing a service, such as working a full or part-time job and receiving a salary, commissions, or tips.
Earnings generated from self-employment or materially participating in a business and getting paid are two other forms of active income. One of the potential advantages of being paid by the hour is that an employee may have the opportunity to earn extra income by working overtime and on weekends and holidays.
Examples Of Active Income
1. Salary
If you go to work at 8 in the morning, leave at 5 at night, and make a set salary for your efforts, you are earning an active income. Essentially, you are trading a year’s worth of your time and skill-set in exchange for a set amount of money.
2. Hourly Wage
Of all the forms of income, the hourly wage is probably the most common. You can make an hourly wage as a teenager delivering pizzas, or as a full-time job as an adult. You could even make an hourly wage as a side hustle at night. One of the best benefits of this form of income is that oftentimes, it comes with the opportunity to make overtime.
3. Commissions
If you are in sales, then any commissions you make are a form of active income. And, of all the active income streams, this one has the most potential to make you a significant amount of money. A good example of this would be real estate agents. When a real estate agent sells a home, they make a set commission. So, if they sell a $500,000 home, and make 3%, then they just earned $15,000.
4. Tips
There are many jobs out there that offer the opportunity to make tips. From serving at a restaurant to delivering furniture to caddying at a country club, whenever you earn a tip, you are making an active income.
5. Consulting And Freelance Services
Consulting and freelance services are two of the best ways to make an active income. So, if you have a marketable skill set, or you can help a company improve an area of their business and generate more revenue, then you should consider this.
For example, if you are a great photographer, videographer, web developer, graphic designer, or writer, then you could start a freelance business offering those services to clients. On the other hand, if you have a deep understanding of digital marketing, social media, logistics, or business operations, you could offer consulting services to companies that need help in your area of expertise. Many consultants make an unbelievable living with this active form of income.
Pros & Cons of Active Income
THE PROS
- You get an instant return on your effort (or every two weeks or so from your paycheck).
- Income is fairly stable.
- You can use the income you get immediately for other ventures.
THE CONS
The downsides of active income largely stem from the fact that people prefer the idea of making money without lifting a finger:
- You only have limited hours and energy in the day.
- There is a legal limit on how much active income an individual can earn.
- As you get older, active income becomes less appealing.
CONCLUSION
For most people, active income is earned before passive income can be generated. Often times real estate investors work a full-time job to earn active income, then reinvest as much as possible to begin building a passive income stream from things like rental properties.
Active income is important because it allows you to earn an income quickly and consistently. Unlike passive income, which can take years to build, active income offers you the opportunity to make money in a short period of time. Additionally, more often than not, active income provides people with the means to build a passive income. As always, it is important to note and weigh the pros and cons of passive income and active income, then decide on which you should opt for.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
