The Three Types of Income

Most people associate income with the cash they earn from working in the office for a 9-5 job. However, there are actually two other income types that one can be earning even without consuming much of their time. An individual has the potential of setting themselves up for financial freedom if they combine these three forms of income.

The three types of income are: active income, portfolio income, and passive income. Read on to learn more about them.

Active Income

This is the kind of income we all start off with — it’s the income that you actively earn, by trading your time for money. Most people are earning active income, but the downside is that active income is also the most heavily taxed income.
The best example of active income is an employee or self-employed person working, trading their time and skill for an income. It could be hourly, or not, but they’re receiving the money because they’ve provided a service.
Within this category, there are still ways to strategize your taxes, but your options are limited.

Passive Income

This is income that you earn from owning assets that requires no work on your part.

Pros

The benefit of passive income is that you don’t have to sacrifice your time to earn it. Instead, the assets that you own are able to produce income for you while you sleep.

Cons

It’s wonderful to own $10,000 worth of stock index funds that produce $300 in dividends annually, but it takes time to accumulate that $10,000 for the initial investment.

In addition, if you earn passive income from something you create from scratch like a website or small business, this requires a huge time commitment up front. Something I often tell people is that “it takes a lot of active work to generate passive income.”

Portfolio Income

Portfolio income is income from investments, including dividends, interest, royalties, and capital gains. I would say that portfolio income is a subset of passive income.

Examples
At it’s very basic, capital gain, or portfolio income, is the income you generate when you sell a stock for more than you paid for it. So if you bought a stock that costs $150 and then sell it when the market says it’s worth $300, you’ve made $150 on that stock, and the $150 is considered your capital gains.

Another form of portfolio income is dividends. Dividend income comes from owning a particular form of stock or fund. After an appointed amount of time, typically once a quarter, companies pay out cash dividends to their dividend stockholders out of their earnings during the quarter. It’s a great type of income to add to your portfolio to help diversify it and keep the cash rolling in.

Pros vs. Cons of Portfolio Income
Capital gains are a great way to start earning bread outside of your earned income. You take that new found moolah, invest it, and now your money is working twice as hard as you. This can be considered a drawback since it means you need to have means in order to access this kind of income. However, even a small amount in the market, over time, can make a large difference, and there are investing apps that help you get started for just $5.

Also, long term capital gains are taxed at a preferential rate if you’ve held the stock for a long enough period of time. This means that you’ll pay taxes at a lower rate than earned income, which can make it even more attractive as a form of accumulation.

Dipping into all three forms of income can generate the most amount of money possible with two forms involving little to no work. Of course, all investing involves risk, including the potential loss of principal. How awesome does that sound? If you are smart about your money and establish a plan for your passive and portfolio incomes strategically, you could potentially earn enough consistently to quit your active income job. Planning out your forms of income can eventually have your money work for you instead of the other way around.

Staying knowledgeable of all the ways you can earn extra money through passive and portfolio has the potential to allow you to live a worry-free financial lifestyle.


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