What is the first word that comes to mind when you hear the word income? If I had to guess I would say the majority would think of wages or monthly salaries. Those who belong to the white collar world could also say bonuses, pensions and stock option benefits that come with jobs. This view is to be expected since a lot of people grow up witnessing employee parents go to work everyday and receive a paycheck at the end of every month.
In a broader sense, income refers to the money received on a regular basis. This inflow can be sourced from other channels – not just the fixed monthly salary. The act of regularly earning money can be categorized in two ways; through Linear Income (or Active Income) and Residual Income (also known as Passive Income). Someone charting his financial freedom roadmap will benefit in learning about the difference between the 2 types of earning because it greatly helps put things to perspective.
What is Active Income?
Active or Linear income, also known as active income is the type of income most people are familiar with. Regular employees, self-employed individuals and even small business owners earn this way. It is called linear income because it stays at the same range even after a significant time has elapsed and its increases are ever so slightly. People who go to work everyday and receive roughly the same amount of money each month earn a linear income. Another name for linear income is active income, this is because those who receive it need to stay active in order to keep earning. As most workers would understand, losing a day’s worth of work also means not getting paid for it – if you don’t or can’t work, you earn nothing.
Most people live their lives as employees receiving fixed income every month. While there is nothing wrong with that, most capacities that pay with a linear income involves a daily routine, like getting up early every morning, doing the same work and seeing the same people everyday – whether you like them or not, and a lot of people want to change this. Generally speaking, most people can survive on their active income whether employed or self-employed as long as they’re active and working. Having an active income is generally the first step to creating a passive or residual income.
What is Passive Income?
Passive or Residual income refers to the type of positive cashflow one receives on a regular basis even when not exerting active effort. It is money earned without any on-going involvement. Those who receive residual or passive income have the ability to do something right one time and get paid for it over and over again. Passive income can come in the form of enduring payments from retirement plans, pensions, or financial investments. Other examples of residual income are music royalties for songwriters, syndication for producers and publication for authors.
A passive income provides long term financial security without a fixed commitment. Unlike active earners, people who earn passive income are able to convert their skills and knowledge to continuing money in-flow while also getting to keep their time. This extra time enables passive income earners to devote their energy to activities they are genuinely interested in – like spending more time with the family, travelling or pursuing a passion project.
Residual Income – The Goal
Active income is great in many ways but it is more difficult to attain true financial independence through active income alone – no one is able to work forever. If the universe decides that you will no longer be able to work tomorrow either through age (retirement) or incapacitation (accident or medical concern) , who will take care of you? Your parents, kids?
While I agree that children should be eternally grateful to their parents and always lend a helping hand, I also believe that being prepared is still the best option. Being financially secured means no awkward conversations like asking money from your kids and no heartaches due of being rejected. Children of financially secure parents are able to live independently and focus their energy and resources toward their own family.
Having a passive income is the key to real financial freedom and wealth creation because unlike our bodies, money and investments grow stronger with time. If everyone is financially prepared the culture of dependence will not persist.
Do as the Romans do.
In the book Think and Grow Rich, Napoleon Hill closely studied and identified the habits of wealthy people to find out the formula to their success. Applying Hill’s approach today should inspire one to brainstorm on passive income ideas more. This is because a study from the Tax Policy Center found that the rich make majority of their wealth through residual income from their business and investments.
If you’ve ever asked the question “How to get rich?” perhaps you ought to start thinking and acting as the rich do and set the goal of making your passive income greater than the number on your monthly paycheck.
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