Income is any money that comes into your bank account or paid to you.
There are three types of income: active, passive, and semi-passive.
There are other ways to classify income that I will not cover in this article, including portfolio income (which is any income from investments, such as dividends) as I don’t consider this a helpful conceptualization. I will also not cover one-off income that is associated with debt (e.g. personal loans) or gifts, as I do not consider this to be income.
With that said, let’s look at active income.
Active income is money received based on your time and is directly correlated with how much you work.
It requires you to work for the money. When you stop working, the income also stops.
This can also be considered earned income.
Examples include your wage or salary, tips, freelance work, and commissions.
This income is the easiest for most people to make and is accessible to everyone. Everyone can gain employment, and if they aren’t, they are eligible for benefits or welfare.
However, the drawback to this type of income is that there are so many hours in the day. The amount you earn is limited to how much you are able or willing to work, and you are not able to scale this income without working harder or longer.
Passive income is money received or value realized through the ownership of assets.
For example, you can own real estate and receive passive income by renting it out. You can own stocks and shares and receive a regular dividend. You can own intellectual property rights, such as to a book, and earn royalties from that.
This is often one of the most desirable income types because you don’t need to work for it. Once you own the asset, you receive the check with little to no work, effectively making money as you sleep.
However, it does require you to own assets or have enough capital to buy assets. For many people, this is not possible, at least initially.
This third type of income is a mix of both. It typically requires a lot of work upfront, but turn into an income-producing asset down the line. This income-producing asset may be fully passive or require minimal work to maintain the regular income.
Examples of this include starting a business or setting up a website/blog.
For me, this is the best type of income. It often allows you to gain passive income without the high level of capital required to obtain/purchase the asset. As you are building it, you have full control. Over time, you can automate the work by paying people, making the income produced by the asset more passive in nature.
What Types of Income Should I Focus On?
Most people already earn a wage or salary. This is the best way to start your path to increasing your wealth.
However, your focus should always be to diversify your income, or transition to more passive income, as opposed to active income.
This is because, as we have seen numerous times during recessions and the recent pandemic, your job isn’t always as secure as you think it is. And we certainly cannot rely on our pension.
So, you really have two options if you want to reach financial independence.
You can join the FIRE movement and dedicate yourself to a strict program of frugality and savings. This is a very good option if you have a job that you spend a lot of your time in, and don’t have much spare time.
The basic premise is you reduce your expenses as much as humanly possible, increase your income as much as you can, and then dedicate yourself to saving 50-70%+ of your income. You then pour those savings into index stocks, which allow you to compound and grow your nest egg. In 10-15 years, you should then be able to retire if you wanted to, using your portfolio of index funds to pay for your expenses indefinitely.
If you’d like to learn more about this method of reaching financial independence, read my article on the FIRE movement, or check out PlayingWithFire.com and watch their very informative documentary on the FIRE movement, featuring the likes of Mr. Money Moustashe and Vicki Robin.
However, not everyone has the dedication and self-discipline to do this. As a result, I would suggest most people maintain their active income to cover their expenses while using their spare time to create and build income-producing assets.
This is what I do with websites. This website, for example, not only educates you about personal finances and supports you to become financially free, but it also includes links to products and services I highly recommend. In return, I earn an affiliate commission and this allows me to earn enough money to pay for the upkeep of the website and, hopefully in the future, to supplement and replace my active income.
If you don’t want to build websites, that’s ok. You can use the same concept and start a business, or build a following on a social media platform and monetize that. Or you can even build houses and rent them out.
Your options are endless.