The term “Income” means money that is earned from doing work or received from investments. Income is the revenue received for goods or services, or from other sources, such as rents or investments. If you can establish multiple income streams you’ll have various cash flow sources coming in and you will be in a much better position to fulfill any financial endeavors even if one of your sources of income fails.
If you want to go down the road to being financially independent, the best place to start is by learning about the available options you can immediately work on such as your income. Millionaires and Billionaires today are where they are because they get their finances together and decide on which income streams to pursue and earn from. It, therefore, becomes a financial safety net for them.
TYPES OF INCOME STREAMS
There are mainly three types of income and they are active income, portfolio, and passive. There is also a small subset of passive income called non-passive income.
- Active Income
This is the most basic form of income stream. It’s the income that we get in exchange for our time and effort like the salary from our jobs. It doesn’t matter if you’re doing it full-time, part-time, or as a second job, as long as you’re pouring your time for money, it falls under this category. Active income is usually subject to federal and state income taxes. Active Income means monetary compensation received from services rendered and includes all the taxable income and wages you get from working or from certain disability payments.
The growth of salary happens at almost a fixed rate. Also, if a person wants to increase their salary income, they often have to work more hours. As people get older, the possibility of increasing the number of hours reduces. This is because the level of their physical fitness decreases. This also means that their responsibilities towards their family and society take up more of their time. Hence, it has been observed that salaried income reaches a plateau when the person is in their middle ages. Post a certain age, salary increments only cover the rate of inflation.
Also, it needs to be noted that salaried income is one of the most highly taxed sources of income in the world. In most developed nations, salaried income is taxed at almost 50%! This means that once a person crosses a certain income threshold, their motivation to earn income also reduces because of the high rate of taxation. Examples of active income are: wages; salaries; tips; and other taxable employee compensation. Earned income also includes net earnings from self-employment. Freelancing is also a form of earned income. Nowadays, there are abundant freelancing jobs available on the internet, which you can do as a second job to supplement your income.
- Portfolio Income
Portfolio income is income generated from selling an asset, and if you sell that asset for a higher price than what you paid for it originally, you will have a gain. Depending on the holding period of the asset, and other factors, that gain might be taxed at ordinary income tax rates or capital gains tax rates. Interest and dividends are other examples of portfolio income. For instance, if a person buys shares and sells them at a higher price or if they buy a house and sell it for a profit, the difference is called a capital gain.
This income has no relation to the number of hours worked. Also, this income is not received periodically. It keeps on accruing over a period of time and is paid out when the investor decides to liquidate it. Also, this type of income is more tax efficient as compared to earned income. This is true only if the investments have been held for a long period of time. Capital gains are not a form of income per se. Capital gains simply define how your portfolio income will be taxed. Income is income and is therefore taxed. This income might be taxed at capital gains rates or ordinary rates. Subtle difference. Portfolio income is not subjected to self-employment taxes.
- Passive Income
Passive income is another important source of income. It shares the characteristics of active income and investment income. Just like earned income, it is paid for every period of time. However, the quantum of income does not depend upon the number of hours invested. Rather, it depends upon the capital invested. Typical examples of passive income are rent, interest, and dividends, which are paid by shares and debentures. Passive income is income that would continue to generate if you decided to do nothing. Passive income includes rental income, royalties, and income from businesses or investment partnerships / multi-member LLCs where you do not materially participate.
Passive income is also not subjected to self-employment taxes. But similar to portfolio income, it might be subject to the Net Investment Income tax. So, if you own a rental house, the income generated from the rental house is considered passive income although your participation might be considered active.
Here are other types of income streams that you should know about.
1. Profit Income
A Profit income is one that you can get by selling something for more than it costs you in a business. This is the second most common source of income and unlike earned income, the amount of money you’ll earn won’t heavily depend on your time and effort. Profit Income is the benefit realized when the amount of revenue gained from an activity exceeds the expenses, costs, and taxes needed to sustain the activity.
2. Interest income
Interest income is the amount paid to an entity for lending its money or letting another entity use its funds. On a larger scale, interest income is the amount earned by an investor’s money that he places on an investment or project. Interest income is the money that you earn by lending your money and charging interest or it could be from a savings account or time deposit. This is a great source of passive income, and there’s minimal risk, especially for the savings and time deposit.
A very simple and basic way of computing it is by multiplying the principal amount by the interest rate applied, considering the number of months or years the money is lent. If you want a passive income where you won’t need to put in much effort to grow your money, this is the type that does that. Interest income may seem like it has the lowest return of them all, but in the long run with a good amount of money in place, in compounding interest, this will be the ultimate passive income that many of us could only dream of.
3. Dividend income
This is another source of passive income, it’s much like interest income but better. You become a shareholder of a company and at the same time earn from the amount you’ve invested in them. Dividends are money you earn from publicly listed companies for buying a share of their company. It’s basically an interest you get for investing in a company via a broker.
Dividend income is defined by the IRS as any distribution of an entity’s property to its shareholders. While they are usually cash, dividends can also be in the form of stock or any other property. Usually, dividend income is the distribution of a company’s taxable income to its investors.
4. Rental income
Through a rental income, you earn by renting out an asset or property. Income received by the taxpayer for allowing another person’s use of the taxpayer’s property. refers to revenue earned from leasing properties, such as commercial spaces, to third parties. This income is clear cut and probably among the most dependable but the drawback is that you have to have a property or an asset that is rentable. You may need to shell out a good amount of money to obtain such valuable assets.
Despite the investment that you need to have this kind of income, it’s worth noting that owning a property is already a good investment opportunity itself. You can choose to sell it if your rental income doesn’t serve your purpose anymore.
5. Capital Gains Income
Capital gains are profits from the sale of a capital asset, such as shares of stock, a business, a parcel of land, or a work of art. Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate. It’s the money that you earn for buying and then selling an appreciating property or asset. It’s almost like a business, the difference is, that you’re flipping a valuable asset (like properties, cars, or even a website) instead of low-cost products.
It involves investing in something for a lower price with the intent of selling it for a higher price. It can be anything from stocks, vehicles, stamps, antiques, or even action figures, as long as it’s about generating more money from buying and selling.
6. Royalty income
Royalty income is income received from allowing someone to use your property. Royalty payments for the use of patents, copyrighted works, natural resources, or franchises are the most common. Many times, the person using the property does so to generate revenue. It’s about making money from using a concept, idea, or product that you own. You don’t need to do the heavy lifting for the business to earn money, you just lend them your intellectual property and you get paid for it.
One good example of this is a famous fast-food chain like McDonald’s. The owners of these brands are paid by their franchisee for using their processes, their logo, and marketing, as well as their business name, to earn money. Other than businesses and investments, royalties also apply to the following media: original music, original products, videos, images, and books.
7. Residual income
This type of income is a form of passive income where a product you’ve created continues to generate money for you. Residual income is income that one continues to receive after the completion of the income-producing work. Examples of residual income include royalties, rental/real estate income, interest and dividend income, and income from the ongoing sale of consumer goods (such as music, digital art, or books), among others.
With the advent of digital media today, residual income generating platforms are now more common than you think, they just need tremendous effort for you to get started. Some of the easiest ways to have a residual income include: selling a book, selling a course, being an affiliate marketer, starting a Youtube channel, launching a podcast, etc.
CONCLUSION
A thorough understanding of an income stream that works best for you, putting in the work that it needs to flourish, and having the patience to sit through the entire process is the key to financial freedom. There isn’t a shortcut to making money, but honing more than one of these income streams and being good at them will make your financial endeavors easier to conquer, and ultimately achieve your financial freedom.
The goal of creating multiple income streams should be to maximize your potential in each category available to you. If you are just starting out, it isn’t expected that you generate tons of rental income immediately. However, if you start maximizing your income-generating potential through your primary salary, you will find yourself having excess income that you can reinvest to generate additional income streams and earn more money.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
