Active vs Passive Income

So, you want to be financially independent, whatever that means. You want financial freedom. Basically, you don’t want to work 8-5 until you die. If you want freedom, then you need an income.

In fact, you really need your income to be more than your spending (unless you’re super rich or near death). I know, I know, it doesn’t take a rocket scientist to figure that out (or a financial planner), but stick with me. You can have an active income, a passive income, or some combination of active and passive.

Dividends make great passive income sources

Active Work

Most people primarily think of active income which is money generated from work. Active income can be increased two ways: work more hours, which may mean a second or third job, or get a higher rate of pay. Hourly employees can sometimes achieve both at the same time if their employer allows it by working overtime.

During one of my summers in college, I worked 60 hours per week in a manufacturing facility, so I got paid an extra 20 hours per week at time and a half. It was hard work but definitely worth it in my young, single life. I was getting paid $15 per hour, which was quite good for a college student in 2007. The extra 20 hours per week meant I got $22.50/hr x 20 hours per week = an extra $450 per week.

Now, if only I could go back and start a Roth IRA instead of upgrading to a newer Jeep. There is nothing wrong with active work; it is good. I would even say we were made to work.

Passive Income

The second, less commonly known type is called passive. As the name implies, passive doesn’t require as much ongoing effort to bring it in. However, passive usually involves substantial effort up front and may require some level of risk taking. You probably need to invest some of your active income to generate future passive income.

The beauty of passive income is that once you get it set up, it keeps producing while you either continue or reduce your active work. As your passive income grows, you can invest in more future passive income with your current passive income.

As you age, you should begin replacing some of your active work with passive income. This can be as simple as contributing to a 401k throughout your career or as complicated as you make it.

The line between passive and active can quickly become blurry, and that’s just fine. It doesn’t always have to be one or the other. For example, rental income might be considered passive if the property is well-maintained and you have good tenants. However, if you are doing maintenance every weekend and have bad renters, it can seem quite active.

Other passive income could come from things like royalties, interest, or stock market returns.

Leave a Reply

Your email address will not be published.