What are Active Income and Passive Income?
“If you don't find a way to make money while you sleep, you will work until you die” - Veteran investor Warren Buffett. But what does he mean when he says, ‘Make money while you sleep’? In this article, we will explore the concepts of passive and active income, their differences, and a few ways to earn a passive income.
What is Passive Income?
Passive income is what you earn when you don't actively work or put forth constant effort on a task/job. It includes regular earnings from a source other than your employer. Simply put, it is an income source that will make you money while you sleep.
Examples of Passive Income:
Returns from stock/mutual fund investments, dividends, rental income, royalties from book sales, and YouTube revenue are the best examples of passive income.
What is Active Income?
Income earned by performing a service or work actively is termed active income. All the income sources that require persistent work and effort are active income sources.
Examples of Active Income:
The best examples are salaries, wages, and commissions earned from jobs and professions.
How to Earn Active Income?
The most traditional and popular method of earning active income is through full-time jobs. The skills, knowledge, and expertise you have in an area get used for the job. A professional job requires a college degree, while a non-professional job does not. You can look for job openings online on platforms such as Linkedin or in newspapers.
You can also earn an active income by offering freelancing services such as writing, video editing, coding, designing, etc.
What is the Difference Between Active and Passive Income?
- Active and passive income are two types of income sources that differ only in terms of effort and time spent to earn them.
- An active income can only be earned by devoting a significant part of your time and effectively applying your skills or expertise.
- In contrast, passive income eliminates the need for active involvement after the initial effort. However, periodic maintenance and upkeep are required for some passive income sources.
Why is Passive Income Important?
“Passive income” has become one of the most trending topics over the past few years. But why is there so much hype around it? Its rising popularity can be attributed to people's desire to make extra money without too much effort. A few reasons why you should have a passive income are discussed below:
1. Beat Inflation
Inflation is the increase in the general price level of goods and services in the economy. It eats away the purchasing power of money. With a passive income, you earn more money which can be used to meet expenses comfortably during periods of rising inflation.
2. Financial Freedom
Financial freedom is a desirable condition of having enough money in your bank account to cover your expenses without having to work, run a business, or rely on others. Having a passive income can improve your chances of financial freedom as the extra income can be invested in the long term.
3. Reduced Stress
The inability to pay bills and meet expenses is one of the leading causes of stress and anxiety. By sourcing extra funds through passive income, you will be left with more money that can be used to meet expenses comfortably and on time.
Passive income can give you more freedom and flexibility to pursue personal interests and goals. Spending quality time with family and friends, travelling, and exploring new hobbies can become a reality as passive income sources can reduce work hours.
Passive income helps you diversify your income streams. Not having a backup source of income will greatly affect you if something happens to your primary income. It will also give you additional income hence increasing your purchasing power.
5. Early Retirement
Multiple passive income sources can create higher surplus funds that can be invested for the long term, which can mean early retirement. Reliable passive income sources can also contribute to retirement income.
Pros and Cons of Active and Passive Income
|Active Income||Reliable, consistent income, career advancement||Requires more time & energy, limited earning potential, lack of flexibility|
|Passive Income||Flexibility, unlimited earning potential, diversification, financial independence||High initial investment, inconsistent & unpredictable income.|
Importance of Diversifying Income Streams
As the saying goes, “Don’t put all your eggs in one basket.” Relying on a single source of income is not financially intelligent. If the single income source is to stop, you might be in big trouble. Multiple passive income sources will cushion you during financial adversities and help maintain financial stability.
For example, a large number of companies went out of business and many lost their jobs during the pandemic. If they had a source of passive income, the layoff wouldn’t have affected them much.
This is why diversification of income streams is crucial.
Myths About Passive Income
Here are a few myths and misconceptions about passive income sources:
1. Passive Income is Always Reliable
Some types of passive income are unreliable. For example, stock dividends might fall during an economic crisis as the companies’ profits might reduce. Rental income may also decline if the property is mismanaged or not maintained properly.
2. Passive Income Requires Huge Initial Capital
While a few passive income sources require high investments, plenty of options do not. Buying and renting out a property requires high initial investment and maintenance costs while starting an online blog or course can be done at minimal costs.
3. Passive Income is a Get-Rich-Quick Scheme
Passive income is not a get-rich-quick scheme. It requires patience, hard work, and dedication to create a sustainable and reliable source of income.
4. Passive Income is “Completly Passive”
Although passive income needs less work than active income sources, it still requires periodic maintenance and review to sustain and grow the income stream.
Mistakes to Avoid When Pursuing Passive Income
Below are a few tips that you should follow when pursuing passive income to increase your chances of success:
1. Perform Due Diligence
Before committing to any passive income streams, thoroughly research the available options and understand the risks involved. Due diligence can minimize the risks associated with passive income investments and increase your chances of success. It's important to be patient and take the time to thoroughly evaluate any investment opportunity before committing your funds.
2. Diversify Income Streams
Diversification is crucial when it comes to passive income. Investing all your money in a single source can be risky as it increases your exposure to potential losses. So you’ll need to allocate your money across various financial instruments or industries.
3. Maintain Risk to Reward
High-reward passive income sources can be attractive, but they often come with the same level of risk. It is essential to balance the risk to reward when selecting passive income streams.
4. Don’t Underestimate the Effort Involved
Even passive income streams require some effort and maintenance. Being realistic about the time and effort required to manage your investments and income sources.
How Much Money Can You Make From Passive Income?
The major drawback of active income is scalability and earning potential. Even though it has a higher earning potential in the short-term, passive income sources can earn you more in the long term and possibly in the short term too. The amount of money that you can make from passive income sources depends on several factors such as the type of income stream, the amount invested, the scale of operations, and performance level.
Passive income sources such as trading and real-estate business can generate huge returns if you have sufficient capital and the right strategies.
Future Trends and Opportunities in Passive Income
In the era of digitization and technology, there are lots of opportunities for earning a passive income. Web3 and Artificial Intelligence (AI) have opened up earning opportunities like never before. It is clear that the future will be technology intensive. Therefore, future trends and opportunities lie in tech and related areas.
In conclusion, there are two kinds of income sources: active and passive. While passive income is generated through investments and doesn't require constant attention or effort, active income involves exchanging time and effort for money.
Both types of income have advantages and disadvantages, but passive income offers greater flexibility, scalability, and the potential for more significant long-term returns. However, it requires careful planning, research, and a willingness to accept some level of risk. Ultimately, multiple sources of passive income are what we should strive for. You can achieve a more stable financial future by using your active income to invest in passive income streams!