There are two types of income: active and passive. You might have heard about these types of income but feel a little confused about the difference between the two. So here’s a beginner’s guide to active and passive income to clear up your confusion.
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Consider what Robert Kiyosaki, the bestselling author of “Rich Dad Poor Dad,” once said, “the key to financial freedom and great wealth is a person’s ability or skill to convert earned income into passive income and/or portfolio income.”
There’s a hint in that quote – earned income is known as active income and it’s convertible into passive income. There are many ways to earn income, with a job, through your own business, or through investments. And, earning your own money is empowering, but so is getting your money to work for you, so you can earn passive income as well.
Are you ready to learn all about the differences between active and passive income?
What Is Active Income?
A person earns an active income by working part-time or full-time under an employer or through their own business. Those who earn active income usually receive payment on a fixed schedule. Some are paid daily, others fortnightly, per project, or once a month.
Among notable examples of active income are the following:
- Salary/wage
You earn a daily wage salary if you go to work in the morning and log out at night, or vice versa. The wage is paid in exchange for your time, skillset, and service. Working overtime for additional income is also an option if you’re a wage earner.
- Commissions
If you’re in sales, you may earn commissions for each sale you make—sometimes on top of your salary—which is another form of active income. For example, real estate agents earn a commission every time they sell a property, receiving a fixed percentage of the total sales price as their compensation.
- Tips
These are also considered active income and are paid based on the level of service provided to their customers. People working in hospitality and foodservice often receive tips from satisfied customers on top of their fixed salary or an hourly wage.
Get inspired to be your own boss to earn your active income by listening to this episode of The Purpose of Money Podcast, as I talk with Kenna Craver about Buying an Online Business.
What is Passive Income?
On the other hand, passive income is generated with minimal effort. It is for people who want to get out of the rat race and enjoy their lives minus the financial worries. Imagine earning money without the stress of 9-to-5 and dealing with mean bosses or annoying co-workers.
Among notable examples of passive income are the following:
- Display ads
In the world of online business, you can earn passive income with display ads. To do this, you should have a blog or website with considerable traffic first. The more you build up your website content and gain page views, the more you can make a passive living through display ads.
- Rental properties
Since it usually requires a huge upfront investment, property rentals can be a higher-risk form of passive income. If you can’t find a renter, you can’t earn money. But, if you have the cash to invest, rentals can be a reliable source of revenue if you find reliable tenants to occupy your property for a consistent period.
- Limited partnership
Being a business or real estate investment partner can be another way to earn passive income with potentially high returns. However, higher returns also mean potentially higher risks. Then again, risks are part of running and investing in a business.
Learn more about creating passive income for yourself in this article about Passive Investing.
What are the Differences Between Passive and Active Income?
You should already have some idea of the difference between passive and active income. This section will further explore the difference between them and discuss how toavoid money mistakes.
Passive income is money you make without putting in a lot of effort or time. You don’t have to do anything for it, but you need to work up-front. Passive income can be earned by investing in real estate, stocks, bonds, retirement funds, interest on savings, and dividends from investments.
Passive income is often confused with residual income, but these are two different things. As the name might suggest, residual income is the remaining money after paying off bills and other financial obligations.Passive income requires minimal to no effort. Passive income cannot be residual, while residual income can be passive.
Active income provides the source for creating passive income. If you have saved enough money from your active income, it can be a great passive revenue source to invest in stocks or buy a rental property. Realistically, it can take months or years to get an ROI, and income flow may be inconsistent.
Passive income is also subject to potential tax deductions, while active income is always taxable.
You need a specific skill to earn active income, but it allows you to make money consistently.
How to Make the Most of Active and Passive Incomes
The more active income you can earn and save, the more opportunities you have to earn passive income. The more passive income you have, the more you can take risks and even consider retiring from your current job.
Here are ideas to maximize your earning potential:
- Ask for a raise
It’s not easy to ask for a raise. But if you want to earn more, you should provide strong arguments why you deserve a pay increase.
- Shift to freelancing
The good thing about freelancing is getting as many clients as you can handle. You can find potential clients online, such as Upwork, 99Designs, Fiverr, and LinkedIn, among a few.
- Be a tutor
Do you excel in a specific subject or skill? Why not profit from it and teach students and other people who have challenges tackling these topics?
- Sell your crafts
Do you have a talent for making jewelry and other novelty or artisanal items? You can sell them on your website, Etsy, and other similar sites.
- Unleash your inner chef
If you have confidence in your cooking skills, you can get paid. Create mouthwatering dishes for clients for a reasonable price.
- Babysitting or pet sitting
You can also make extra income by babysitting a neighbor’s child or someone’s pet. It can be a challenging but fun experience.
- Be a mystery shopper
Get hired to shop and report your experience. Legitimate organizations are looking for mystery shoppers.
Takeaways
Earning money is empowering. It gives you purchasing power if you learn to manage your money well. Active income lets you make money consistently in a given period, while passive income is a way to let your savings earn extra cash for you, even while you sit back and relax.
It’s great to make money both ways because it lets you expand your portfolio and save faster for your future.
