Active Vs. Passive Income: What Is The Difference (Beginners Guide)
20 years ago almost nobody knew that there existed different ways to earn money apart from your full-time job.
But as more people nowadays are aware of passive income sources and various types of income, it’s crucial to describe the difference between active and passive income.
The Difference Between Active and Passive Income
Many think that passive income is like some kind of magic wand that you can just swing, and it will overnight make all your problems disappear.
This couldn’t be further from the truth.
Yes, some of the best ways to supplement your regular and ordinary income are to build passive income streams, but building a passive income-producing asset is not as easy as financial gurus and mentors want you to believe.
On the other hand, active income is the paycheck you receive every month from doing actual work.
This article will help you get a better understanding of the differences between passive and active income. Additionally, it will give you examples of different active and passive income ideas.
Generally, passive income is earned from income-producing assets that the investor purchased with money earned from an active salary or other compensation.
It can also be earned by investing upfront work and time now and here such as building a YouTube channel that earns you income in the future.
Besides not having to spend multiple hours a day generating passive income, investors do not pay social security or medicare taxes on passive income, and they can therefore reduce their income tax liability with an array of potential tax deductions.
Be aware that some active and passive income streams might overlap with each other.
For instance, working on a youtube channel or a blog online will be mainly active income in the start due to all the work it requires, and only when it earns money without their involvement will it be passive.
Thus many passive income sources were actually active income sources in the beginning.
Passive Income Examples
Here are some examples of passive income streams.
Investing in the stock market
This is a great way to earn money passively. When investing in the stock market, one can earn money in two ways.
Either one earns money from price increases in the stocks they already own, and sells them.
Another way is to generate a consistent cash flow by holding beautiful dividend stocks that on an annual, semi-annual, quarterly, or monthly basis pays dividends.
- You can automate your investments, and therefore everything is transformed into 100% passive activities.
- Potential for high earnings
- Almost guaranteed a return if you just invest in large indexes such as S&P 500.
- Compound effects will result in your income growing exponentially in the long term
- There will always be risks, and you could potentially lose money
- You need money to make money
Another well-known passive income stream is owning rental properties.
When one owns a rental property, every month he or she will earn residual income through the paid rent minus the expenses the owner might have.
If you choose to have a property manager maintain the properties and fix potential issues the tenants might be facing, this would get even more passive.
But rental income can be obtained in multiple ways. A great example is renting out an RV, which can be a lucrative income stream if done correctly.
- It’s more or less passive income
- It can be scaled by increasing your property portfolio
- Through real estate investing you also earn additional money when you sell a property that has appreciated in value.
- You need a great amount of money for a down payment
- Can be a nightmare if you don’t know what you are doing
- Not 100% passive, and your tenants might not pay on time
Generally speaking, affiliate income is a referral commission you earn every time someone makes a purchase with your specific affiliate link or code.
And affiliate marketing is something many companies use in their business activities to generate revenue.
This means there are lots of opportunities for you to receive this form of passive income.
- Potential earnings are infinite
- Easy and free to start
- It’s passive once it is all set up
- Fierce competition
- Need a large audience to profit a lot from it
Unique things outside your house
If you choose to build something outside your house so unique that it will catch the attention of many, this could be turned into a passive income stream.
For example, you put a box outside for people to put a dollar in, in exchange for a photo of whatever you’ve built.
Once you’ve built your thing, it doesn’t need your direct involvement any longer.
- It’s a passive income stream
- Takes a lot of time to build and come up with ideas
- Not that scalable
Passive sources of income can be almost anything, also digital products such as an online course, graphic design templates, eBooks, and so on.
However, this will be a form of active income for the first long period, until you’ve established yourself in the market.
- No need for a warehouse
- Need to work a lot to have great digital products
- Can be hard to gain enough trust to make sales
If you’ve ever worked a regular 9-5 job or gotten an hourly wage you’ve been earning active income.
While active income might not be the sexiest thing in the world, it’s the easiest way to make money and it is important for improving your personal finances.
If it weren’t for active income sources, it would be almost impossible to build passive income streams.
Try chewing on it for a moment.
- To make an initial investment into the stock market you’ll need money.
- To work online you’ll need money for a computer, the internet, and maybe even some online tools, and therefore you’ll need to work hard on making an active income simultaneously to sustain that.
Active income is income one receives by trading their time for a salary via a full-time job, operating a business, or doing freelance jobs.
Most people only have an active source of income and no other income streams.
The underlying reasons for only pursuing an active income are as follows:
- People are only thinking short term.
- Society teaches humankind that trading time for money is the best way to make money.
- People have bills and responsibilities to pay each month.
Active Income Examples
As you can imagine there are many examples of active income, and here are a few:
When working a part-time job, you are often paid an hourly wage for your active participation.
The hourly wage might also be the best-known kind of active income.
You can earn this type of income from a freelance business, a regular job, and some side hustles where you are paid by the hour.
- The only positive thing about this type of income is that it offers the opportunity for overwork, and therefore additional income.
- You need to trade your type for money, which means less time doing the things one really want
- This income is limited by the number of hours in a day – you cannot scale it
- The only way to earn significantly more is to increase your hourly wage, and that is difficult if you are employed.
Running a small Service business
When one runs a small service business, he or she might be the founder, owner, and CEO but still need to work actively to generate enough money to survive.
While entrepreneurship sounds sweet in many people’s ears it still requires much effort, and most small business owners are trading their time for money.
- You are your own boss, and therefore more flexible.
- The one determining the prices of your services or products is you.
- Better opportunity to scale your income through price increases.
- You are trading time for money.
- Although you control your price, you are still limited by the number of hours in a day.
When you work on freelance platforms like Fiverr or Upwork, you are doing work upfront and putting active effort into delivering your service.
Whether the price is fixed or based on an hourly wage you are trading your time for money, and that’s exactly what active income looks like.
- You have your own clients and can often work from the comfort of your own home.
- The only one determining the price is you. If you don’t the customer’s price you don’t take on the job.
- Can be hard to get the first customer, and you might have to take on terrible jobs at the start.
- If you work on the freelance platform, these have their own special rules, and they take a cut of your revenue.
- Hard to scale the income
This type of income has one of the highest potentials to increase your net income by a lot.
Although you are putting in active work, the extra money you can earn from this can be significant.
For instance, real estate agents often earn a particular percentage of a property sale. If the agents sell many high-priced houses their annual income will skyrocket.
- High-income opportunities
- Can be scaled a bit by increasing the commission percentage
- You are trading your time for money
- If you don’t sell, your income will plummet
Which is Best: Active or Passive Income?
Don’t lie to yourself. Passive income will almost always be the best type of income, however, it depends on your current situation.
If your savings accounts are close to zero, then active income from a job might be the best income in the short term for you.
Remember, passive income takes time to build, so if you cannot afford to survive it wouldn’t be a great time to try building a passive income.
When that’s said, passive income gives you more freedom, location flexibility, and control over your own life.
You can be taking a swim, spending quality time with your loved ones, or improving yourself while earning money.
If that’s not better than trading away your time for money, I don’t know what is.
But we should never dismiss the importance of active income since it often fosters the foundation of passive income.
People Also Ask?
How Can I make $1,000 Passively?
There are hundreds of ways to make $1,000 passively. You could invest in dividend stocks until your portfolio income reaches $1,000.
Another way is to start a blog and display ads on it, get sponsorships, and implement affiliate links.
A third option is to develop apps and monetize them through ads.
The list is infinite, and it can be hard to generate $1,000 each month from only one passive income source.
Therefore, try to combine a lot of different passive revenue streams, and eventually, it will add up.
What is the best passive income?
When determining the best passive income, everything depends on your values and current situation.
But you should factor in variables such as “how much time would I like to spend building it?”, “how much must it earn me?”, “can I maintain it in the long run?”, etc.
The simple answer is that there doesn’t exist any “best passive income”, but you decide.
What is the best active income?
Just like there doesn’t exist a best passive income, there’s no best active income either.
If you work most efficiently when employed, then a job is what you should choose.
On the other hand, if you like freedom, and being your own boss, then operating your own small freelance business might be a better fit for you.
What are 7 types of income?
- Earned Income.
- Profit Income.
- Interest Income.
- Dividend Income.
- Rental Income.
- Capital Gains Income.
- Royalty Income.
What are good side hustles to make an active income?
A great side hustle depends on your passion, how much time you have for hustling, how much money you can afford to invest in it, and so on.
Some of the best side hustles from my personal experience are:
- Writing on medium: Here you earn money based on how many people read your articles and how long they stay. I’ve had months earning me +$2,000
- Freelance services: I made +$1,200 in my first month on Upwork
- Helping neighbors sell stuff they don’t use anymore, and then split the profit (this is a very unique and profitable side hustle)
How to transform a side hustle into a passive income source?
First of all, not every side hustle can be turned into a passive income.
Thus, the first step is to have a side hustle that’s suitable for this transition.
Next, you need to automate as much of all the processes that go into generating money until it requires close to zero maintenance.
Finally, you need to be consistent and patient in the startup phase, since passive income sources take time.
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