Why not have your money earn you income? Better yet, why not have money deposited into your bank account from work you previously completed?
Limiting yourself to one type of income is a very risky way to make a living. The purpose of this post is to explain the three types of incomes and advantages and disadvantages of each.
The most common type of income that you’re familiar with would be earned income. Simply put, earned income is trading dollars for hours.
Earned income is very easy to obtain, but very easy to lose. If you get fired, you lose your income.
My favorite type of income is passive income. Passive income is income received from work you have previously done.
- Owning rental properties
- Types of online businesses that need little or no direct involvement
- Royalties from publishing books or music
Earning 100% of your income from passive sources takes a little more creativity but can easily be done, especially with the Internet. There are a many ways in which you can start earning passive income online very quickly. Examples include writing an e-Book to creating an online video.
All it takes is a little education to open your eyes. I once thought passive income was unattainable. However, after reading books like The 4-Hour Workweek, I’m starting to develop sources of passive income myself.
If you have a savings account, you have received portfolio income. Portfolio income is income derived from paper assets like stocks, bonds, money market accounts, savings accounts…etc
There are three types of portfolio income.
- Capital Gains – Income from the sale of a paper asset
- Dividends - Income from earnings passed down to shareholders
- Interest - Income from investments such as savings, checking, CD’s, money market accounts, and bonds
One disadvantage of portfolio income is that you need to invest a lot to earn a lot. Therefore, it’s not until later in your life that you can live solely off of your portfolio income.
The Importance of Diversification
The typical path to riches today is to accumulate as much earned income as possible and build a portfolio of stocks and bonds. Once you no longer want to exchange your hours for a salary, you begin to live off portfolio income.
This way of building wealth is pretty simple, but it’s risky. As we have seen in 2008 & 2009, portfolio income isn’t very stable and earned income can disappear fast.
An important theory to managing assets, that is commonly associated with investing in the stock market, is diversification. Diversification is the opposite of putting all your eggs into one basket; instead you put many eggs into many baskets.
Diversification is not just important to managing a stock portfolio; it’s also a good practice to diversify your income. If one source of income gets turned off, you have another one to replace it.
The Key To Diversification Of Income
Since you’re trading dollars for hours, there is a limited amount of diversification you can achieve through earned income. I.E., you can’t have three full time jobs.
It’s easy to diversify your portfolio income through index funds. However, you have no control over performance of each individual fund. One option are fixed investments like CD’s, but it takes a lot of money upfront if you wanted interest from a CD to provide enough income for you to live off. Plus, you also face reinvestment risk if interest rates were go down.
Out of each type of income, passive income is the income you have most control over. Plus, you can have as many sources of passive income as you like. Which makes it the safest and most sustainable type of income you can have.
If you start learning how to turn earned income into passive income, financial freedom and abundance isn’t far away.
In the comments, please discuss any sources of passive income you’re interested in creating or have already created. With a creative mind, the possibilities are endless.