We all love money, and we all want to be making more and more MONEY!
I’m sure you would agree that the role of money plays an important part in how we all live. We believe, more money can help us find more happiness, lead a comfortable life and reduce financial stress.
For most of us, the only income we typically are aware of is the one related to our work (career/job) or Business. While income from your career or business is certainly an important means to make a living and have access to life’s essentials, it’s not the only income that matters.
In this article, let’s understand – What are the different types of Income Streams? What are the different types of income you can create and earn? Will earning more money make you happier?
Types of Income Streams
There are two types of income streams, active and passive.
Active Income :
Most of us have a job and are making this type of money. This is also referred to as your ‘Earned Income’. You go to work, put your efforts and get paid (salary, commission etc.,). There is a direct link between your efforts and your pay-check. But the problem with active income is it’s only scalable up to a certain point. You can only get so many pay hikes and you only have so many hours in one day.
Examples of earned income are:
- Working per hour at a company (full-time or part-time)
- Being a salaried employee for a company
- Freelancing/consulting for clients or businesses
Maximizing the potential of earned income is perhaps the most important aspect of generating wealth that is often ignored by a large number of people. You can use your active income to invest in various asset classes or to implement your business ideas, to generate extra cash-flows.
Passive Income :
Passive income is where the income is not directly linked to the work you do. So, it comes for free? Although it says passive income, there is still work required to generate the revenue. You got to put your efforts (time) up-front and/or deploy resources (capital) early on, and the income (cash flow) comes later. This is like something you’ve already put the effort in and are reaping the benefits now, with much less effort.
We can further classify Passive Income into Profit Income, Investment Portfolio Income and Residual Income.
Different types of Income, to generate extra Cash-flows (or) build wealth!
If your main income is your daily job but you are looking for ways to create new income streams, these are the types of incomes available to you!
Business Income or Profit Income :
You can go beyond your job and become enterpreneur. You can create a product or service at a cost and sell it for a higher price (margin) and earn a profit. You require lot of guts and conviction, to shift from an earned income profile to profit income profile.
You can be an investor in a business or a silent partner, but you are not the person heading the enterprise. You may start small but note that the possibilities are endless with Profit income and best of all, IT’S SCALEABLE!
Investment (or) Portfolio Income :
Portfolio income is money you receive from your Assets in the form of dividends, interest, rents or capital gains. These assets can be – Stocks, bonds, mutual funds and real-estate properties.
If you have idle cash, you can put your money to work, invest in Bank Deposits and earn an interest on it. When you lend money to any entity, you earn interest which is a small amount of money paid in return for the principal amount. This is interest income in a nutshell.
You may not make abnormal returns, but your investment is not exposed to high risk as well. Investing in Govt Bonds (with sovereign guarantee) can also fetch you some passive income.
A dividend is when a company pays a portion of the income the company has made through the year to the shareholder(s). You go to work every day and save some money for investments, invest that money into a dividend-paying stock, and receive either monthly, quarterly, or yearly dividend payouts.
In case, you aim to build your own business empire, you can pay yourself handsome dividends from your own company 🙂
If you have substantial investment to be made, can purchase a real-estate property and start receiving rental income. Property investment is one of the most popular ways to generate passive income. However, you need to make huge investment up-front and the cash-flows (rents) may take some time to get released.
You can also take a home loan based on your ‘Active income’, this is called leveraging and buy a rental-generating property. But, keep in mind, over-leveraging can be very dangerous, and you may fall into financial distress. You make sure the income you receive from your tenant covers your loan EMI and leaves something for you.
Suggested reading : Reverse Mortgage (Home Loan)
Captial income is the income you receive for selling something at a higher price than you bought it for. Some examples of capital gains income are:
- Buying and selling stocks, bonds and mutual fund units
- Buying and selling real estate properties
- Buying and selling valuable commodities like gold or alternate investments
Inherited income is the income you would receive from parents or other family after their death. As a legal heir or beneficiary, you may inherit properties, receive bank deposit proceeds, shares etc., Sometimes, managing a huge inherited wealth can be a challenging task. You can streamline the incomes generated from these assets and aim to create more wealth for your next generation.
Residual Income :
Residual Income and Passive income are used interchangeably. Residual income is where you continue to get paid even though you were done the job/product a long time ago. A residual income stream can be a passive income stream but may not be the other way around. Some of the prime examples of this type of income are;
- You can create digital content via blogs, vlogs, YouTube videos etc., Let’s take my case as an example. Though I was away from active blogging, for almost two years, between 2001 and 2023, my blogging work had generated decent revenues.
- You can develop a course-ware or publish a book and get royalties paid.
Taxation of Active & Passive Incomes
Be it your active income or passive income, they are subject to taxes. But, in most scenarios, your active income is subject to higher tax rates. Whereas the various passive income streams can be more tax efficient.
You can further re-invest the cash-flows generated from the above income streams in appreciating assets, to build your long-term wealth.
A robust method for accumulating Wealth and establishing financial independence is passive income. Even if you don’t pursue every avenue as listed above, find ways to increase your income streams beyond just your job. Whatever you decide is a personal decision, but always remember the importance of having more than one income stream in place.
Be it active or passive income, you got to have the right skill-set and mind-set and/or required capital, to get wealthy! But don’t overindulge yourself in this money-making game. Else, you may end up getting exhausted and stressed out. You need to enjoy the whole process of making additional money and do it passionately.
Remember, more money should enhance your overall well-being and that should be the end purpose of your income!
My Passive income cash flows come from – Rental income, Dividend Income (very miniscule as of now), Revenue through my Blogs, Interest Income, Capital Gains and Business Income (as a silent partner). How do you generate extra cash-flows? How are you planning to build your Wealth? Do share your views in the below comments section. Cheers!
Continue reading :
- Where do you fall in the Cash Asset Quadrant? | What is the path to become Wealthy?
- 5 Personal Financial Mistakes that I have committed…!
- Long Term Investment Horizon : Importance & Benefits | My father’s risky investments! (Real-life examples)
- My First job interview experience | A life-long memorable one!
- Job Resignation Checklist : Employee Benefits & Personal Finances
(Post first published on : 27-July-2023)