Most of us fail to recognize the financial mistake we are making, often unconsciously, of not having the complete know-how of incomes and types of cash flow.
The mistake can cost you more than you can think of.
We all have grown up being mostly familiar with only one type of income; the income we earn by doing a job!
We have heard and seen it all around us.
But there is much more to income.
While earning is the most eminent form of income, there are two other types we should be well aware of to develop our financial IQ and always excel in our monetary decisions.
Have you played Monopoly when you were young?
If yes, you must be well acquainted with other forms of making money that was included in it, even if you were unfamiliar with the terms at that time.
Remember purchasing property and collecting rent from other players whenever they landed on your site?
How fun was that!
How we were always desperate for people to set their footing on our property so that we can EARN!
Next, to double our returns, we would focus on increasing the value of our property so that we can sell them when deemed suitable and gain profits!
It was a clever move then, it is a clever move now, in real life!
These are the types of income most of us did not really consider under this category.
But there are more ways of generating money than simply earning it by a tedious 9 to 5 job and what is imperative right now is to understand them.
If you desire to make your money grow and not only survive on the bare necessities of life, it is important to know everything about the types of income and how to produce them.
So let’s cut the wait.
The three types of incomes are:
1. Earned Income
2. Portfolio Income
3. Passive Income
Let’s dig deeper into them!
If you have a job and you receive a paycheck for it, you are generating money for yourself through earned income.
Pretty familiar, right?
As quite evident from the name, earned income is the income generated by working for a designated number of hours and receiving a payment in cash for it.
What you are really doing here is exchanging time for money.
For example, if you are an employee in a company as a graphic designer, or as a software engineer, or if you are a teacher in a school, a police officer, a baby sitter, you are getting a fixed amount of money as a payment for working for a predetermined number of hours.
Pretty simple to understand, isn’t it?
The most common ways of generating earned incomes include:
You start making money as soon as you begin a job.
Most payments are made monthly, a few bi-monthly depending on the agreement made between the employee and his employer.
This is the biggest advantage of earned income, consistency.
Also, there is no need to rely on an initial capital for this type of income.
In fact, earned income is the smartest move to pave your way for the other two types of incomes, allowing you to save up prudently and effectively utilizing it in your investments later.
For these reasons, most people rely on earned income as their first choice of generating money, starting as early as they can.
But one cannot ignore the downside of earned income.
Here are a few you should know.
You say goodbye to earned income as soon as you stop working!
In addition to this, you often end up working more than the required hours, doing additional shifts, and investing extra energy since earned money is directly proportional to the amount of energy and time you put in.
It gets challenging to earn extra money without keeping yourself up to date with emerging knowledge and learning new skills.
Furthermore, earned a higher tax rate accompanies money as compared to other types of incomes. A feature that sits well with none of us.
Simply put, portfolio income is generated on capital gains, for example, by selling an investment at a price higher than you originally bought it at.
Imagine you buy a stock in a company for $20.
As time passes, the price goes up to $50. That’s when you decide to sell it to gain a profit of $30. That $30 is your capital gain.
There are several ways you can generate Portfolio Income:
Trading your assets like stocks, mutual funds, bonds, ETFs, Currencies, etc. Investment in the stock market is the most common form of –> generating portfolio income.
-> Buying and selling Real Estate
-> Buying and selling other assets
Portfolio income has an advantage over earned income when it comes to making profits.
With a profound knowledge of investing and proper insight into companies you are investing in, you can reap the benefits for a really long time and also reinvest after every sale.
Something that earned income is unable to do for you. Likewise, they are taxed at a lower rate as compared to earned income.
Now let’s talk a little about its disadvantages.
You cannot begin investment without having apt knowledge about the investment options and companies you are considering to invest in.
With meagre knowledge, you are more likely to go in loss, also putting your earned income in danger. No one wants to do that!
Portfolio income is not available to you on your will, and often you have very little control over it, except for your ability to buy or sell your investments in some cases.
Therefore, it takes a while before you can actually benefit from the profits.
Also, you need a considerably handsome amount upfront to begin your investment. Often small investments don’t turn out as beneficial as you would hope for.
Now coming towards Passive income, the income you make from the assets that you have created is the passive income.
You might have heard it like a gazillion times, “Your house is your biggest asset.”
Well, it can’t be more true!
If you were to rent your house or a part of it for money greater than it costed you on the mortgages, the income you would earn would be considered as passive income.
Similarly, if you have a business that is earning profits for you irrespective of you working full-time, all the income generated is your passive income.
Passive income is the most fun and exhilarating way of earning money.
Why? Because you have already done your work, now you are only reaping its fruit.
Another great example is the Royalties.
Once you have created intellectual property, for example, a book, a song, a website, you can easily license it out and start collecting royalties which will add to your passive income.
Some great ways to make passive incomes are:
Passive income certainly has more advantages as compared to the other two types of incomes.
You generally have more control over your passive incomes as compared to the other two.
For example, if the source of your passive income is your house or an apartment, you have active control over the day-to-day activities.
This can directly impact the value of the asset and ultimately, income.
Furthermore, this type of income is a recurring one.
One you are over the hard work of building and creating your assets or running a successful business, you can consistently rely on a monthly or yearly income it generates for you, without you having to do additional work.
This means you can retire and still see your wealth growing potentially.
In terms of taxes, passive income has an edge too.
The profits you have accumulated can be used to invest in other passive investments like Real Estate, often with tax deduction taken into consideration.
Furthermore, trade or real estate defers tax inevitably.
Robert Kiyosaki firmly believes, and we completely agree,
“A wealth person is simply someone who has learned how to make money when they are not working”.
How fascinating does it sound! But this only possible when you get past your earned income and steer towards passive and portfolio incomes.
No doubt, your earned income gradually weaves your way to start investments and make assets that are utilized in passive and portfolio incomes.