We all need some income to survive and afford essential goods and services. However, having a single income stream is dangerous since the loss of income can lead to financial ruin. It is more prudent to diversify and seek multiple types of income.
Learn the various types of income you can generate and how to build multiple income streams.
What Is Income?
Income is money generated through the exchange of labor, goods, and services or by investing capital. Individuals usually earn wages and salaries, while businesses profit by selling their products and services. Individuals and companies can also generate income by investing their excess capital in income-producing assets.
The two main types of income based on how you make your money are
- Active income
- Passive income
Active or Earned Income
Any money you earn from your salary, hourly wages, tips, and sales commissions falls under the earned income category and is considered active income.
Earned income is relatively straightforward to understand compared to other types of income. In addition, it is also what you typically use for purchasing assets that will provide you with passive or portfolio income in the future.
The vast majority of people will earn money via their primary source of income. In most cases, this is a traditional job. People will work a job, earn a salary, and get paid for their work. The salary that you make and the taxes that you pay ultimately depend on your specific personal conditions. This type of income stream – usually your active income – is critical to your long-term financial success and stability.
Maximizing earned income is often as simple as improving human capital, working harder, finding a higher-paying job, leveraging high-income skills, and doing what you can to minimize your income taxes.
Passive income comes in two forms. The most effortless form of passive income is due to owning assets. Typical examples are real estate passive income due to owning a rental property or investing in an apartment building. Similarly, the interest on your money in a bank, I-Bonds, and dividends are passive.
The other type of passive income, though it sounds effortless, does require significant upfront work. You must put in the hours initially to later enjoy your profits passively. For example, you need to spend the time and energy to write a book and get paid later for every book sold. Music royalties, patents, or even starting a blog follow a similar model.
For example, you can take the money you generate from a side gig and use that money for investment purposes and create a capital gain. As such, you can use cash to generate income positively.
What are the types of income you can generate via passive income? Let’s take a look.
Investment income is any revenue you generate when an asset appreciates and is sold for more than its purchase price. It commonly takes the form of stocks and real estate, yet it can also apply to collectibles, including comic books, baseball cards, or art investments. Additionally, selling a business also qualifies as investment income!
Investment or Portfolio income has an upfront cost. You have to have the money to invest in a stock, mutual fund, bond, or other financial instrument. However, in theory, that asset will gain value, provide dividends, or generate interest. You can then use that money to create a passive income stream that you can either reinvest or spend.
There are many kinds of investment or portfolio income.
The stock market is the most popular way to generate passive income. Picking individual stocks takes work. There are several categories of stocks – growth, value, and speculative stocks.
- Dividends: Many stocks will pay dividends which means they will regularly (usually quarterly) generate additional cash for you to either use or reinvest. These dividends are generally determined by how much stock you own. Dividend income is a widespread form of passive income and is commonly regarded as one of the most valuable and stable passive investments a person can make. If you invest in the right stock or several dividend aristocrats, you can generate investments that can help you for your entire life – including retirement.
- Capital gains: Capital gains is the term used to describe what happens when you invest in a stock or bond and sell that stock or bond when it increases in value. The profits are known as capital gains.
Instead of picking individual stocks, you could also invest in low-cost index funds which passively track an index. Investing in S&P 500 is relatively easy, and the S&P 500 has provided substantial capital gains and dividend income over the last few decades.
Remember, investing in stocks without risk is impossible. One cannot generate stock portfolio income risk-free. As such, you’ll need to gauge your appetite for risk before making risky financial investments.
Fixed-income investing is a strategy focused on preserving invested money and income from the invested capital.
Bonds are loans that companies or governments take from private investors.
Government bonds in the form of Treasury bills, Treasury bonds. Treasury Inflation-Protected Securities and I-Bonds are the most secure bonds and are backed by the U.S. Government.
Municipal bonds are a form of government bonds that are riskier than U.S. Treasuries since they depend on the local government’s ability to repay.
Like governments, corporate entities sometimes need large sums of money to invest in infrastructure, facilities, mergers, acquisitions, etc. and issue corporate bonds.
Individuals often keep their money, including emergency funds, in an interest-bearing account, like a saving account. Savings or money-market accounts generate more interest income compared to a checking account.
Although these interest rates are usually relatively low and don’t match the current inflation rate, the interest rate and principal are risk-free. You cannot lose money in an FDIC-insured savings account.
A Certificate of Deposit (CD) is a fixed-income instrument issued by banks or credit unions. CDs have Federal Deposit Insurance Corporation (FDIC) or NCUA insurance and are more secure than corporate bonds. Ensure you check the FDIC limits when buying CDs.
There are many other forms of financial investments that you can make, and some are highly, highly controversial. Investing in cryptocurrency is a relatively new field. Cryptocurrency is an asset independent of stocks, bonds, and other traditional financial measures. It is a highly risky field. More to the point, it is largely unregulated, meaning that unscrupulous investors or exchanges can make off with your money. As such, you should use extreme caution before investing in cryptocurrency and using this income to enhance your overall portfolio income.
If you are short on capital, remember that you don’t need much money to make your dollars work for you. All you need is to start investing. Thanks to the power of compound interest, you can allow your investments to grow more and more, thus enhancing your total nest egg.
Investing With Borrowed Money
Some individuals and investors engage in a complicated process, although one that can ultimately be highly lucrative. Investors may borrow money and invest it in the stock market. There are many ways that this process – known as borrowing on the margin – can be worked.
The risk here should be apparent. If you make money on your investment, you can turn a profit, using your investment profits to pay back the loan, including the interest, and pocket the difference. However, if you don’t make enough profit – or if your investment doesn’t pan out and you lose money – you may find yourself in debt.
As such, this is a much riskier idea than most other types of income available to individuals and should only be used with extreme caution.
As the name implies, rental income allows you to rent out an asset of yours and then generate regular, steady income with that rental property. Investing in real estate is among the more popular types of passive income.
The most common type of rental income involves leasing one of your rental properties to someone. It usually comes with a hefty upfront investment, as you must purchase a property, prepare it for a rental, and engage in legal costs to schedule the rental.
One can invest in real estate with little to no money down but it involves a lot of sweat equity.
First-time landlords are often worried about the tenant screening and management process. RentRedi is landlord-tenant software that makes it easy for landlords to manage their properties. RentRedi enables landlords to list properties, screen tenants with TransUnion-certified background checks, receive mobile-submitted rent, and manage maintenance requests.
IRS considers owning a rental property as passive income, although it is not, by any means, a passive investment. It usually requires active management, as you’ll have to keep your tenant happy, market your property, and be prepared for any legal disputes that come with the ownership of a rental property.
Even if you know the landlording basics and have a property manager, you still need to review and approve the property manager’s tasks.
Generating rental income comes with risk. In addition to heavy upfront investment, you’ll have to ensure that you take necessary action to protect your asset. It means ensuring that whoever you rent appropriately cares for the property and doesn’t damage it. If there are damages, you’ll have to make sure you have the legal structures that allow you to recover any financial losses due to damage from your renter.
Fundrise has one of the lowest minimums (only $10 for the Fundrise Starter Portfolio and is one of the top crowdfunded real estate platforms.
PeerStreet has equity or debt investments on its platform. For debt deals, you provide hard money loans for others to buy the property. The advantage of PeerStreet is that you can filter debt deals by Loan To Value (LTV) and also stressed LTV. PeerStreet has a low $1,000 minimum and has an optional automated investing feature that automatically places you into investments that match your criteria.
Furthermore, remember that one can generate rental income with various items at this point. Indeed, the widespread popularity of numerous apps has made buying property no longer necessary for rental income.
If you are interested in using your home to generate passive income, renting space may be a low-effort way of helping you accomplish your goals. You can turn unused space in your garage or driveway into an asset without people in your living space.
Sign up for Neighbor and get paid to store things. You can earn $100-$400 per month as passive income with unused space. You get to pick WHO, WHAT, and WHEN items are stored. And the platform comes with $1,000,000 host liability protection.
You can also generate this earned income by renting out many assets, including cars, boats, swimming pools, and more.
The average family’sfamily’s RV will sit unused for approximately 90% of the year. List your RV on RVShare. It is free to join, and you could earn up to $40,000 in additional income per year from your RV when you aren’taren’t using it. You are in control of your rental, which means you set your rental price and how many nights a renter can take your RV
You are entitled to royalties from that product if you create any type of work, such as a book or music. Royalty income is an additional income stream that starts as active and then turns passive.
Royalty income can be generated from various sources and allow you to reap the financial benefits of your creativity. How much royalty you generate ultimately depends on the specific type of creative work that you create.
Furthermore, it depends on how much work you go into marketing your creation and the specifics of your royalty agreement with your publisher.
Any content creator will tell you that considering royalty income as passive income is folly. While you may be able to generate some income without doing any active work, there is still extensive work that goes into creating something useful and engaging that can capture consumers’ attention.
One of the newer and more accessible forms of royalty income has come from content creators on platforms like YouTube.
YouTube has emerged as an easy way for content creators to generate royalty payments. To be clear, to get a piece of the ad spend on YouTube, you have to reach specific metrics for viewership and subscribers. However, once you do that, you can create a channel that generates revenue on your behalf. Furthermore, you can engage with brands to create sponsorship deals, thus further developing your income stream.
As you can see, this is not a passive form of income. It requires real work to get a YouTube channel up and running, to market that content, and manage your channel.
However, it may generate enough momentum to get an audience without non-stop work once it is up and running. It enables you to develop a healthy side-stream of income.
Podcasts and websites are other similar avenues. Setting up a website or blog is considered active in the initial phase because you need to produce content. But, the internet provides infinite leverage in terms of audience. The content created once can be sold repeatedly, with no extra cost.
If you are interested, check my guide on how to start a website in 10 minutes, with examples of content you can focus on creating.
Are Side Gigs Worth It?
The term “side gig” has become increasingly popular over the past few years and can technically be classified as active or earned income.
However, since one can lose their primary job at any point, it is best to diversify active income with side hustles.
More and more people have used the power of the internet to develop different types of income, using their skills or passions. Also, the timings of these side gigs are flexible, allowing one to work on them as desired without any commitment.
A person can find nearly countless types of side gigs, including the following.
The need for high-quality, creative talent is more significant than ever, and an individual with the right business and creative experience can create an extremely lucrative side-gig that can help them generate some extra income. A slew of freelancing websites exist that allow a person to create their own profile and market services that they sell. It can include copywriting, graphic design, voice-over work, editing, and more.
In some cases, there are specific websites for each of these fields. Or individuals can use broader freelance websites – like Upwork or Fiverr – to advertise their services.
Individuals in these fields often work on a contract basis, completing a job before moving on. Freelancing as a side gig can give an individual the flexibility they crave while also helping someone supplement their main income stream.
An upfront investment is usually not directly required to register for one o these freelance sites. However, competition on these sites is often fierce, and getting started may be challenging.
As such, a potential freelancer will want to spend some time – and possibly some money – making sure that their skills and presentation to potential customers are the best possible. It can help a person stand out, earn more clients, and generate more cash.
When most people think of side gigs, they probably think of service-oriented gigs. There are many options for this, including:
- Working for a ride-share service like Uber or Lyft
- Picking up groceries and dropping them off at someone’s house
- Delivering food via DoorDash or GrubHub
- Walking pets
The low bar to entry and increasing demand for people to work in these arenas have created incredible opportunities for many people.
Working in these fields allows individuals to develop a lucrative side gig that can supplement their income. At the same time, these jobs are often highly flexible, giving people ample opportunity to work – or not work – when they want to.
It is certainly possible to create a long-term income stream from these gigs, but the pay is often not as good as someone would find when working a more traditional, 9-5 job.
As such, the ability to use one of these side gigs full-time is much more limited.
Many individuals are fortunate enough to be born with artistic talent. For a select few, it is possible to create works of art, music, or writing that enable them to become successful in the long term. For others, this may be more difficult.
However, thanks to the popularity of websites like Etsy, many have found that it is now possible to create works of art that are highly personal and highly lucrative.
Individuals with arts, crafts, or other creative art skills can create products they can sell on the internet. Websites like Etsy can assist with the success of these artists, as they can allow individuals to create highly personalized and effective digital storefronts.
Of course, Etsy is not the only website that can assist with this process, but it is one of the most well-known. Furthermore, many artists can create robust websites that enable them to sell their products directly and keep most of their profits.
Taxation of Various Types of Income
Income taxes can take a massive bite out of any total income stream. As such, you should work with a tax professional to implement tax strategies to maximize your deductions and keep your overall taxation levels to a minimum.
The internal revenue service is not known for its kindness with mistakes, so make sure you have a conversation with a qualified professional about what you need to do to reduce your overall tax burden.
It is essential to remember that earned income is usually taxed as personal income. Therefore, you should expect to pay higher taxes on your earnings. One could employ several tax saving strategies such as 401(k), HSA, deferred compensation, etc., but active income is one of the most heavily taxed incomes, especially if you are earning it from a W2 job.
Remember that any capital gains income you generate will be subjected to a capital gains tax. Fortunately for you, recent changes to the tax code lowered the tax rate on captain gains income. It means that captain gains income is subjected to lower taxes than other types of income, which makes it one of the more efficient forms of passive income.
For instance, for 2022 taxes, the highest taxation on ordinary income is 37%, whereas when it comes to capital gain profits, it’s just 20%.
How Many Types of Income Should One Have?
Fortunately, you can generate many types of income with some work and research.
Some of this earned income requires more investment and time.
Other types of income can be more passive, meaning they are more in a position where you can “set it and forget it.”
Building multiple passive income streams can allow a person to generate additional sources of money, thus allowing a person to live a happy, healthy, and financially lucrative life.
Your overall financial health is about much more than having multiple income streams. While generating passive income can be extremely helpful to your financial future, it is not enough.
Thankfully, with time and effort, you can build a financial future that enables you to generate extra money and gives you more control over your long-term success to create generational wealth.
John Dealbreuin came from a third world country to the US with only $1,000 not knowing anyone; guided by an immigrant dream. In 12 years, he achieved his retirement number.
He started Financial Freedom Countdown to help everyone think differently about their financial challenges and live their best lives. John resides in the San Francisco Bay Area enjoying nature trails and weight training.
Here are his recommended tools
M1 Finance: John compared M1 Finance against Vanguard, Schwab, Fidelity, Wealthfront and Betterment to find the perfect investment platform. He uses it due to zero fees, very low minimums, automated investment with automatic rebalancing. The pre-built asset allocations and fractional shares helps one get started right away.
Personal Capital: This is a free tool John uses to track his net worth on a regular basis and as a retirement planner. It also alerts him wrt hidden fees and has a budget tracker included.
Credit Karma partners with Equifax and TransUnion and offers free credit reports and free credit scores updated weekly. It also provides alerts when it detects unusual activity on your credit files. Monitoring your credit report for errors can save you thousands.
Fundrise: One of the top real estate crowdfunding platforms for non-accredited investors. Sign up for free and look at passive real estate investment opportunities with low minimum (only $10).
Streitwise is available for accredited and non-accredited investors. They have one of the lowest fees and high “skin in the game,” with over $5M of capital invested by founders in the deals. It is also open to foreign/non-USA investor. Minimum investment is $5,000.
PeerStreet has a low $1,000 minimum, which allows for better diversification for real estate accredited investors. You can define the criteria based on rate, LTV, duration, etc., and use their automated investing feature to place you into investments that match your criteria. Or manually select the investments.