No matter how you make an income, the money you make will fall into two categories: passive income, or active income. And while you may have heard these two terms in the past, many people don’t quite understand the difference.
You may already know there is a difference between passive and active income and you may know generally what that difference is, but it’s likely you don’t truly grasp the implications of those differences.
For the record, there is nothing wrong with either of them. But if you want to maximize your returns down the road, you do want to make sure you really do have a solid feel for how these two differ. This article is aimed at helping you do just that.
- What is Passive Income
- Examples of Passive Income
- Why a Passive Income is Important
- Pros And Cons of Passive Income
- What is Active Income
- Examples of Active Income
- Why Is Active Income Important
- Pros and Cons of Active Income
- What Is The Difference Between Passive And Active
- Which Is Better: Active Income Or Passive Income?
- Why Passive Income is Better Than Active
- How Active Income Can Lead to Passive Income
- 5 Passive Income Streams That Can Make You Rich
What is Passive Income
Passive income is earned when you put your money to work for you. Many also consider passive income to be income from activities that you do for a short time (the set up) but that require very little else to maintain the income flow. You can equally grow your passive income online with MoneyTreeSeed.com if you’re looking to create a business that will keep a steady cash flow coming in.
For example, you might spend some time putting together a web site with affiliate advertising. It requires some up front time and effort, but after a while there is no need for you to put in a great deal of time. The money flows in with very little continued effort and oversight on your part.
Passive income can also come from investments. Dividend stocks and bonds are popular income investments. You put your money in (or set up an automatic withdrawal), and you earn money from dividends or from interest.
There isn’t a whole lot you have to do beyond checking every so often to determine whether your income investments are performing as you like. The money comes in, but you aren’t doing much.
Transitioning into a position where passive income provides more of your earnings is a worthy goal, since it will leave you time to do the things that you want to do. Track your income, as you track your spending, and learn what you can do to improve your cash flow.
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. All that money would be a result of your disciplined investing throughout your life.
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. And honestly, many people do.
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.
Remember when we mentioned that some forms of passive income can take years of work in order to generate significant revenue? Well, this is one of them.
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
We’ve already discussed affiliate marketing and display advertising, but the big winner for online passive income is course sales and info products.
In fact, many people make six -figures, or even seven-figures a year from this passive income stream, alone. The key to this, once again, is to build a large online audience — which, yes, 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.
Why a Passive Income is Important
Passive income is important because your physical presence and effort isn’t continually required in order to make money. In essence, if you have a passive income stream, you can make money at all hours of the day, and every day of the year. So, whether you are sleeping, on vacation, or watching tv, you can still be making passive income.
But, here’s the thing, passive income, in most cases, takes years to build. Whether you are investing, building an online audience though a blog, or saving up the cash to buy a rental property, there is a lot of early — active — work that goes into generating passive income.
You can’t just be lazy and expect passive income to start rolling in. But if you are willing to put in that kind of effort, you could end up literally making money while you sleep. And that’s the goal of passive income.
Pros And Cons of Passive Income
The road to passive income is long and slow. If you’re thinking about going down this road, you should know how it will affect your life:
- Steady source of income: This is probably the most important benefit of passive income. And the good news is, after you’ve established your business you don’t have to work too much to earn money.
- Financial freedom: Passive income will help you reduce stress. You won’t have to worry too much about the bills and you can focus on more important things in your life.
- Retirement plan: A great way of increasing your income is to create a passive source of income which will help you save more money each month. If you save a fraction of that income monthly, you’ll have no financial problems when you decide to retire from your main job.
- Free time for setting up more passive income: The good thing about passive income is, after reaching the point where your service or product is generating good amount of money for you, you’ll have more free time to generate even more sources of passive income.
- No limit for your success: Unlike traditional jobs, there is no limit for the amount of money you’ll receive each month. If you work hard enough and invest in the right business, the sky is the limit for you.
- Time-consuming: In order for your business or product to start generate passive income, you need to put a lot of work and effort at the start. Sometimes up to 60 to 100 hours per week. Also depending on the type of value you’re creating, it takes about a year before you see any sort of profit.
- Lot of attention: Some businesses need a lot of attention to maintain them. A great example is rental properties. It may seem like an easy job to most people, but not only does it take a lot of money but also it needs a lot of attention and care to fix up a house and find the right tenant.
- A lot of capital to start: If you have enough money you can invest it in high yield savings, stock or even real estate, each having a higher potential return. However, there’s a big downside to these businesses as a passive source of income which is you need a lot of capital to start.
- High risk: There is no guarantee if you’re business will succeed. For completely relying on a passive source of income, it’s better to first work on a regular job to make sure your bills are taken care of.
- You might lose money: As mentioned before, it takes a lot of time for your efforts to start generate positive cash flow. It is possible for you to lose some money in the process.
What is Active Income
Most of us are familiar with active income. This is income that comes from our active efforts to earn money. For many of us, this includes working at some sort of a traditional job.
Active income can also come from the efforts you put forth to make money with a side business, or by doing odd jobs.
The main reason active income is called “active” is due to the fact that you have to do something. Often, that something requires a significant expenditure of time or effort.
Even if you make money by sitting in an office all day, you may find that you are still engaged in active income, since you have to go through the process of getting to work, and then you have duties to perform.
Even if it isn’t physically strenuous, it might be mentally challenging. Even a tedious job that is not challenging in any way can actually be considered “active”, since it is quite draining to go through the day in such a setting.
Examples of Active Income
If you go to work at 8 in the morning, and 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 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.
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.
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.
Why Is Active Income Important
Active income is important, because it allows you to earn an income quickly and consistently. Unlike passive income, that 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.
Pros and Cons of Active Income
Earning active income has several advantages. For one, it typically carries lower risk. An individual who participates in an activity to earn income, for instance, isn’t risking capital to try to earn passive income.
Active income is also more predictable. Individuals who receive the same monthly wage and know when it is going to be received are able to plan accordingly.
Employees who get paid on the 15th of every month, for example, might allocate 30% of their wages to mortgage repayments; 50% to utilities, food, clothing, and other expenses; and 20% to discretionary expenses, such as saving for a vacation or dining out in restaurants.
- Carries lower risk than other types of income
- More predictable than other types of income
- Makes it easy to plan monthly budget
- May make individuals complacent and/or averse to risk
- Can limit earning potential
But there are potential downsides too. Individuals who earn active income might become complacent, which could prevent them from discovering new opportunities. An investment banker, for example, may earn a lucrative salary and decide it is not worth taking the risk to open a private hedge fund.
Earning an active income can also limit earning potential. There are only so many hours in the day that an individual can work, which limits the amount of income a person can earn. A freelance writer who bills a client per article, for example, can produce only a limited amount of content per day.
What Is The Difference Between Passive And Active
Active income investing is, while it still may be an actual investment, a job. It is a J-O-B. So many people don’t see it like that, but that is what it is. Flipping houses is a job. Wholesaling is most definitely a job. Also, landlording a rental property is a job.
This is important to understand this because it is a difference of how you spend your time. No-joke big-time investors make money in their sleep without putting in any effort because they invest in passive income investments.
If you are putting in effort, while you might be making bank and doing great at it, you are working. You are making a lot of income because you are rocking out a job. The no-joke big-time investors, if you’ll notice, also put in a lot of effort but their effort is not on what is currently making them income, it is on finding the next thing that will provide them more income!
If you like the “job” of wholesaling or flipping or landlording, or whatever it is you may be doing actively to earn income, rock on with it. Especially if you are using the income from that job to buy passive investments with, which is how one really becomes successful- find ways to fund buying passive investments that will lead you towards financial freedom.
On that note too though, you can work any job or build a business to earn income that you can use to invest in passive investments. It doesn’t have to be flipping or wholesaling or landlording, albeit you do learn a lot about investing working those jobs, but it can be any job you want totally outside of real estate if you want it to be.
Real estate is just a great way to earn some fat cash, which is why so many people stick with it. And if you do that, you are awesome still, as long as you realize you are working a job.
Which Is Better: Active Income Or Passive Income?
To be honest, passive income is better than active income. Think about it, if you have a passive income stream that generates money for you when you aren’t working, then you can take a vacation and come home to a bigger bank account. You can fall asleep, and make money while you dream. Pretty awesome!
That said, active income is, more often than not, the foundation for you to make passive income, so don’t dismiss it. Whether you want to make money from investments, a blog, or anything else, you need to earn an income while you build your passive income streams. So, active income plays an extremely important role.
Why Passive Income is Better Than Active
Active income (which is your usual salary) has a lot of associated costs that come with it. It costs your time and effort, sure. But you also pay taxes on your active income. You have to pay for fuel to get to your job, the home you’re tied to near your work, and plenty of other costs. Passive income doesn’t have any of those problems:
Second, there’s no associated costs with the passive income. No lunches with co-workers, no uniforms, no dry cleaning, and no transportation costs to and from work.
Third, financial independence grants you geographical independence as well. You’re no longer tied to one particular spot. How much would you pay your employer (or give up) to work from home? To work from Spain? To work from the mountains in the summer and the beaches in the winter? To work from… anywhere? What’s the value in that?
While some passive income still requires taxes, those costs can be less cumbersome than on an active salary. Of course, passive income is harder to generate sometimes. Investing, starting a side business, or owning rental property are hard to do.
Especially if you don’t have much to start with. However, they’re goals worth working towards. Arguably, it’s more important than simply boosting your base salary.
How Active Income Can Lead to Passive Income
Interestingly, active income often leads the way to passive income. Here are just a couple examples.
Mechanical engineer Matt Bochnak was always tinkering in his garage with motorcycles—his own and his friends’. One day, he wondered if anyone would pay for his repair service, and sure enough, his ad on Craigslist started to draw in new customers.
The other smart thing Matt did was set up a camera to film himself doing the repairs, which has led to a profitable YouTube channel and even selling full repair walkthrough video files online, effectively turning a service business into a passive income business.
Wes helps teams streamline their sales processes, systems, and workflows. What that often involves is setting clients up with new customer relationship management software, especially when their existing system is outdated (or non-existent). With years of sales experience across dozens of industries, Wes has the knowledge to recommend the best tools for each business.
Passive income comes into play because Wes has affiliate or reseller relationships with many of the services and software tools he recommends. He earns his sales consulting fee upfront and then earns residual income from referring a new customer to a particular software that’s helpful in their business.
Over the years, this “passive” element of Wes’s business has become a substantial income stream. And it all just came from setting up clients with someone else’s products and showing them how those products could bring them more sales.
5 Passive Income Streams That Can Make You Rich
There are several passive income streams. They include rental properties, renting your house or apartment with Airbnb, high yield savings accounts, creating a YouTube Channel, or earn money by just watching TV.
If you’re serious about creating passive income streams, you may want to work with a financial advisor, to help developing a plan to reach your financial goals.
In the beginning, they are not entirely passive. To build passive income, you have to put a lot of work up front, usually with little to no returns for extended period of time. You can go months, even years without a single dollar produced from these passive income streams below.
But once the work is done, they can become completely passive and make you really rich.
Now that does not mean these passive income streams can be completely ignored. No, quite the contrary. It’s important to track every passive income stream, no matter how automated it might be.
1. Start a Blog
A blog, regardless of the niche, can provide you with tremendous amount of passive income.
Again it is not entirely passive, it requires a lot of time and work to succeed. But it’s certainly more passive than getting up every day to go to work.
Once your blog becomes popular, it gives you the platform and audience to generate multiple streams of revenue by monetizing your blog.
You can monetize your blog in two ways: (1) Affiliate marketing, (2) Ads. Affiliate marketing can be a great way to make passive income because when people click on the affiliate links, you receive a commission at no cost to them when they product or service.
The second way you can make money by starting your own blog is from advertisements that you put on your blog. A good example is Google Adsense or Commission Junction. When someone clicks on your ads, you get a commission.
2. Peer-to-Peer Lending
Another way to generate massive passive income is to earn interest when you loan money to others. This is made possible by peer to peer lending. Peer-to-peer lending companies such as Lending Club make it easy to invest in people business and generate passive income from interest payments.
The way peer-to-peer lending works is that people who have money are matched with people who are looking for a personal loan, through an online platform.
These peer-to-peer lending platforms can get you a much higher rate results than a typical savings account.
3. Write and Publish an E-book
An e-book is one of the best passive income ideas. Although you have to put a lot work upfront on the e-book, once it is done and marketed, it can provide you with thousands if not hundred thousands of passive income streams for years.
You can either sell the e-book on your blog or offer it as an affiliate arrangement with other websites that provide content related to your e-book.
4. Invest in Real Estate
Real estate is one of the best passive income streams to make great money and become rich. It has long been the source of passive income for ages. After all, some of the rich people made their billions by investing in real estate.
So, investing in real estate is not only a great way to make passive income, but it is also a great way to becoming rich. At first, it can be an active venture. As with all income streams that are passive, it takes a significant amount of time and effort on the front end.
Read Also: How to Make Money Outside of an Office Job
It also requires time to seek and acquire properties, to come up with finances, etc. But when all of that is done and your property is fully rented, it’s mostly a matter of managing the property and keeping it performing well.
Property management can make the investment much more passive for you. Those property managers can manage your property for you, usually 10% of the monthly rent.
You’re most likely going to need a mortgage loan in order to invest in real estate.
5. Invest in Stocks and Earn Dividends
Some common sources of passive income streams are dividends from stocks. When you buy stocks that pay dividends, you earn dividend income on a monthly or quarterly basis.
Depending on how many stocks you have, you can generate massive passive income by doing practically nothing. To invest in dividend stocks, you would need to open a brokerage account. We would recommend Ally Invest for only $3.95 per online stock trade.
As you already know, we talk about two types of incomes – Active and Passive. The income in which your efforts are actively required is an active income. Simplest example of this is salary. On the other hand passive income is generated with very less involvement of your efforts. Simple example of this is interest income.
What are the limitations of active income:
- Education / Skill – This is the most important factor that determines the quantum of income that can be generated actively. And this is always an upper limit to how much you can get educated / skilled. Though in theory the sky is the limit, practically there are much more than what meets the eye.
- Time – we all have the same amount of time and it too has the upper limit of 24 hrs.
- Age – with age we gain experience however the energy and ability to learn of new generation skills diminish
- Non-working days – illness, leaves, vacations and more more such reasons can lead to trimming of your working days in an year.
- Death / disability – This generally ends the income stream.
The above factors limit your ability to generate more active income.
Now on the other side of the equation, we have passive income. Setting up a stream of income that later doesn’t require much of our time certainly eliminates the above mentioned limitations. Take the case of a dividend received from stock investments. Clearly there is no active involvement required.
The same factors for passive income:
- Education and skill – While there is still an upper limit on this, your passive income is not much dependent on these anymore. take for example income earned through copyright content like royalty received from a published book / music / video / IP / patent. They require onetime creation and mostly very limited maintenance work for the rest.
- Time / non-working days – Interest income doesn’t take any holidays. it rolls on for each day irrespective of you being healthy or ill.
- Death / disability – Income doesn’t stop at your level, you can pass it on to your legal hires and if well planned and executed, it can go on for generations
When passive income generated is greater than your yearly expenses, you have got what is called the financial freedom.