Passive Income vs. Active Income: Why you Need Both

by | Sep 27, 2020

Before jumping into our passive income vs. active income debate, let’s first understand the basics of finances.

The general understanding of managing your finances is making sure you’re not spending more than you’re earning.  This understanding is extremely crucial to financial success.  However, this does not mean your daily expenses like groceries, a day out with friends, or even Starbucks needs sidelining.

These are expenses you incur every day and not things you can ignore! To ensure that you are spending adequately on these, you need to have a steady income.

The money you make falls in either the active or passive income category. You might have encountered these terms in passing and may even have a general understanding of them. However, there are specific implications to both types of income that take time to understand.

On a basic level, we experience both incomes. Your active income is what you earn by working on a regular basis.  This is represented by an hourly wage or even a salary.  Passive income is the benefits you get from a 401k, stocks, or an online business yielding passive sales.

But, if you’re looking to maximize returns on your savings for the future, you have to make sure you understand the fundamental differences between both. When you do so, you are likely to realize that one income depends on another (at least for a period of time).

Nevertheless, everyone has a different outlook regarding their future and long-term goals. This article is to help you understand the distinction between the two.  As well as equip you with a few examples that you can incorporate into your own financial life.

What is Passive Income?

According to Investopedia, passive income is defined as:

earnings an individual derives from a rental property, limited partnership, or another enterprise, in which he or she is not actively involved. “

To simplify this, if you’re given the offer to invest your savings into something that will generate income for years, this is passive income. It requires efforts early on in your life to save up a sizeable amount you can use to receive a passive income that can sustain your lifestyle for a long time.

What Is Active Income?

Active income means you’re doing something in the present to receive the income that you do. It requires diligent effort and hands-on day-to-day tasks. Investopedia defines it as the “Income for which services have been performed. This includes wages, tips, salaries, commissions, and income from businesses in which there is material participation”.

You have to exert some kind of energy and time towards task completion regularly to earn an active income. Keeping both incomes in perspective, passive income does not come to fruition without first earning an active income. While you might not be making money as you sleep through active income, it is what pays your everyday bills.

As you try to understand the distinction between the two, it is important to realize both incomes look different for everyone.  This is especially true based on your spending power. Some people like to splurge and live in the moment while others save up for the future.

Why Does the Source of Income matter?

Your future goals reflect the type of income you choose for yourself. The cardinal rule of living is having goals for yourself. They can be immediate or long-term. When making financial decisions, it is important to see which type of income is better suited to the goals you have in mind.

Those who want financial freedom clearly define that their goal is to invest in something that can give them some sort of regular income without doing something active in the future. They essentially want to break loose of their current career.

In the most basic words, financial freedom means not having to work to receive an income regularly. It is for people who choose a lifestyle where they can do as they please without overtly worrying about the inflow of cash. They work during their schedules, take up projects that they feel like doing, and choose the amount of time they want to spend working in any capacity.

Examples of Passive Income

Following are some examples of passive income that can help you learn ways to start saving up and investing your money slowly

1. Index Funds

Index funds are a way to invest your money in the stock market that is entirely passive. This type of investment is done in the general market where you will not have to concern yourself with choosing investments, rebalancing your portfolio, or understanding when or how to sell your assets.

All of this is done by the fund itself based on the fund portfolio. You can choose whichever index fund is best suited to you because index funds are set up in almost every market that exists. If something particular interests you, you’ll likely be able to find an index fund for it.

2. Affiliate Marketing and Sales

This is particularly good for those who have active websites or blogs as either a hobby or their income source. You can sign up to promote specific products or services on your site from which you will be paid a flat fee or according to the amount of traffic generated by the ad.

This is a pretty simple task as the internet is full of companies looking to market their services or products. Websites like ClickBank are dedicated to connecting potential customers. Try choosing products or services relevant to your site, so there is also genuine engagement.

3. Invest in Real Estate

Investing in real estate is a bit of both types of income. While eventually, it becomes passive income, buying property and its upkeep is a constant effort that needs to be managed by the owner or landlord. Once you’ve bought a property, established it, and put it up for rent, there will be a matter of managing the property and ensuring that it performs well.

Of course, there is no task that others can’t do for you, thus you can hire property managers to take care of your property for you. They take around 10% of the monthly rent. While it takes a chunk out of your cash flow it also saves up the time you would have used for this.

Examples of Active Income

Most of us are familiar with active income. It is something we experience on a regular basis. It includes working traditional jobs. For example, if you’re working at a coffee shop or as a lawyer, you’re putting in the active effort at the job to earn a daily wage, which you get either at the end of your day shift or monthly. It is a lifestyle choice for many people.

Active income can also come from the efforts you put forth to make money with a side business or doing odd jobs. This is why the distinction between active and passive income becomes blurred. Because while you might be earning a passive income, there is a high chance you’re also working actively to increase those savings or side business of your interest.

Some examples of active investments are flipping and wholesaling. You have to work in order to get money from these activities. These are hands-on experiences where you’re dealing with customers directly and are making sure to get a positive return on investment of your preloved clothes.

Hourly Wages, commissions, and tips are examples where you’re able to earn a daily wage and have the benefit of earning more if you work overtime.

What can you Learn from Both?

Some would argue that passive income is a better and more sustainable way to ensure a future free of worries. However, there are compelling arguments against this too. Plus, the amount of work and effort needed to achieve a stable passive income requires years and years of active effort.

Transitioning into a position where you’re able to support yourself through your passive income is a worthy goal since it will leave you with time to do things you otherwise were unable to do. The time that it takes for this transition can lead to a feeling of burn out which deters a lot of people from pursuing passive income as a future goal.

However, more often than not, both types of income take help from each other for an effective strategy for your future plans. One is a foundation for the other.

In the passive income vs. active income debate, both styles of earning profit certainly have their place.   However, to fully maximize your earning potential you should be putting the focus on both.

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