Whether you are a personal finance pro or just starting your journey, learning about active and passive income is a critical step towards taking control of your finances.
In this blog, we are looking at active vs passive income and how to use both to create a more stable overall income. We will also look at the key differences and why it is important to diversify your income where possible.
What is Active Income?
Active income is any income you get from performing a service. This is usually earned as wages, tips, bonuses or commissions. For most people, this is their day job. However, active income also counts as self-employment or business ownership.
Active income brings close to instant financial rewards for the work that you do. You do not have to wait until your work starts potentially generating income. You can also directly control your active income through negotiation and skill development. For example, skilled workers can get higher salaries.
Examples of Active Income
- Salary from a full or part-time job
- Commission from sales jobs
- Freelance income or gig-economy income
- Bonuses for performance at work
- Tips for service workers
- Overtime payments
- Contract work
What is Passive Income?
The definition of passive income is any earnings generated without ongoing active effort or involvement.
Passive income involves effort at the start, as you must set up the income stream first. People tend to underestimate the initial cost of setting up passive income. There are plenty of ‘get-rich-quick’ schemes when you search for passive income, but these can lead to financial losses.
However, once a foundation has been set, you do not need to do anything further to continue generating income.
Learn more about passive income and side hustles here.
Examples of Passive Income
- Stock dividends
- Capital gains
- Interest
- Royalties (e.g. from a trademark, patent or copyright)
- Rental income
Key Differences Between Active and Passive Income
Now we have defined passive versus active income, let’s take a quick look at the main differences.
- Active income can be limited by time and skill levels.
- Passive income has fewer limitations and can often be expanded without extra time commitment.
- Active income requires consistent effort and time.
- Passive income requires more money and time to set up and is not guaranteed to be successful.
- Passive income often requires a certain degree of maintenance, but not as much effort as active income.
Why You Should Diversify Your Income
When your look at your passive vs active income options, you shouldn’t look at them as an either/or situation. The best way to strengthen your finances is by combining both. The more income you have, the more your finances are diversified and protected.
Income diversification is a strategy that reduces your reliance on one single income source. Diversification protects you if one particular source dries up, giving you more financial freedom.
If you rely on only one source of income and it suddenly disappears, you will have to rely on savings or quickly find a new job. This can be a very stressful situation, so it is recommended that you protect yourself and your finances from the start of your journey.
There are plenty of examples of passive income options that you can embrace alongside your main job. For example, you can combine a full-time job with a side gig as a freelancer. This could be tutoring, a blog with affiliate marketing or renting a property.
Keep learning about personal finances today. Visit the Cash Asap blog here.
