Even if you’re happy and believe that your job will be around for a while, there are good reasons to have multiple income streams.
I wish I had known earlier about different ways to make money that didn’t require me to exchange more of my time for a paycheck.
In this article, we’ll explore the different types of income, explain the difference between income streams and sources, and the importance of having an income strategy to support your well-being.
What is Income?
Income is money you earn for exchanging your time, skill, labor, capital, or service. For most individuals, income is earned through wages, either a salary or hourly rate. Some may get income from other sources such as business activities, rental properties, or stock investments. You can think of any money that flows into your life subject to taxes as income.
Why is knowing the types, sources, and income streams important?
The more you understand how income is generated, the less you feel constrained about earning money only through exchanging time. You can make better financial decisions when you understand the various types of income. It helps you to:
- Reach financial goals sooner
- Learn how hobbies can make money
- Quit undesirable jobs and find meaningful work
- Pay off debt sooner
- Feel secure about your future
- Create sustainable wealth
The 3 Income Types
Oftentimes, it’s helpful to categorize income into three types. This method labels income as active, passive, and portfolio.
Active income
The IRS refers to active income as Earned Income. It’s when you receive a paycheck or 1099 form for wages, salaries, commissions, and tips earned. It often means the exchange of time, skills, and energy for money. It also includes any active and material participation in business activity.
For example, you have earned income or active income if you work as a salaried accountant or an hourly barista. Other examples include roles in management, customer service, sales representative, freelancing, teaching, construction, and so on.
Passive income
With passive income, your daily activity isn’t required to make money. Passive income is made from rental properties, royalties, and businesses where you don’t actively participate. Passive income types often require an upfront investment of time, energy, and money but require little effort in the future.
For example, you earn passive income if you have rental properties, investing in a business, or receiving royalties for the use of your art, music, or book sales.
Portfolio income
Portfolio income includes depositing money into an interest-bearing savings account or certificate of deposits (CDs), investing in the stock market where you earn from dividends or capital gains.
If you’re investing in the stock market, you’re most likely earning dividends and interest or capital gains from selling appreciated assets. For example, you own stocks that pay a quarterly dividend, have savings that earn interest, or sell a stock that appreciated from $10 to $15 for a capital gain of $5.
Introducing the 7 Income Streams
Another way of thinking about income is through income streams. There are seven streams:
1. Earned Income
Earned income is earned from your job, whether salary or hourly. It includes your paycheck from your day job and income earned driving for Uber. Earned income is money made when you exchange your time, energy, or skills for money. Keep in mind, your earnings potential is capped because your time is limited. There is only so many hours in a day and only so many hours you can work before getting burnt out.
2. Rental Income
Rental income is income made from real estate rented to someone else. You do not reside in these properties, so the extra bedroom listed on Airbnb doesn’t count. Most millionaires attest that owning rental property and the income generated from them is a great source of their wealth.
3. Profit Income
Profit income is often referred to as business income. It is when you make money as a business owner but do not run the day-to-day operations. Your capital investment offers you a share of company profits. However, you can be both an owner (who gets a profit income) and an employee of the company (get a paycheck). Tax rates are calculated differently.
4. Royalty Income
Royalty income is made by leasing or licensing your work for use by another. This includes books written, music created, or any artwork and protected work paid for by a business or end-user. There are many platforms that help you build royalty income by licensing your photos, videos, content, and more.
The following three income streams fall in the portfolio income type.
5. Interest Income
Interest income is earned when you lend money to others. This includes money loaned to family and friends with interest or money deposited in an interest-bearing savings account. This type of income can be easily added as part of your income diversification strategy. You can begin saving money in high-yield savings accounts and use CD laddering.
6. Dividend Income
Dividend income is a result of your investments in companies as a shareholder. Public companies pay dividends as a share of profits to their shareholders. You can invest in companies that consistently pay dividends. There are many wealth builders who follow a dividend investing strategy.
7. Capital Gains
Capital gains are made when you sell assets, such as stocks, index funds, houses, and other items that have appreciated in value. Whenever you sell any assets, the profit made is called capital gains. Regarding tax planning, capital gains tax is typically lower than ordinary income tax. Depending on your income, the long-term capital gains tax rates are0 percent, 15 percent, and 20 percent.
Why Diversify and Multiply Income
Everyone can benefit from diversifying and multiplying their income. You can benefit by gaining peace of mind and financial security.
To reach financial independence, I want you to start considering ways to diversify and multiply your income.
Here’s what you can do: First, focus on increasing your income from your primary job. Second, earning extra money with side hustles may also be easier, like driving for Uber or freelancing. Third, you might want to turn a side gig into a full-fledged small business. And finally, use your extra earnings to buy income generating assets by investing in the stock market or buying rental properties.
Do you see where I am going with this scenario?
Make as much as you can from active income sources, then use the money to buy assets that help you earn passively.
How Multiple Income Streams Support Financial Wellbeing
It’s best to have diversified and multiple income streams for greater peace of mind. Consider the following:
1. Survive unemployment
There’s no such thing as true job security. Your company may do well today, but things can change in the next month or years. And if you lose your job, money from unemployment benefits may not provide enough cash to cover your monthly expenses.
You’ll be better prepared to survive a layoff or job loss with a second income source. Between your severance, unemployment checks, and a secondary income source, you might be able to keep your head above water until you find anotherfull-time position.
2. Build your emergency fund
Financial experts recommend a 3-6-month emergency fund. But unfortunately, if you’re living paycheck to paycheck, building your emergency fund can prove challenging. This is where a second income source comes in handy. Income from your day job can pay everyday expenses, such as housing, transportation, and utilities, and income from your second source can build your fund.
3. Pay off debt
Whether you have student loan debt or credit card debt, your income from work may not be enough to pay down these balances. As a result, you might get stuck in a minimum payment trap. However, if you start a side hustle or seek part-time work, the extra money can go toward paying off debt.
4. Ability to make ends meet
Even if you work hard and keep your life simple, your income may not keep up with inflation and the higher cost of living. And if you’re in a financial hole each month, you probably have little cash for extras.
Multiple income sources can stop this vicious cycle and increase your disposable income. And with more cash coming in each month, it’ll be easier to cover your monthly expenses, which might reduce some of your financial worries.
Go through the budgeting process to better understand your current financial situation. You can calculate your cash flow through the process–the money in and out within a month. After completing the process, use budgeting apps to keep you on track and monitor your progress with less effort.
5. Fallback career
Acquiring a secondary income source can build your savings, pay off debt, or help cover your expenses — but these aren’t the only benefits. Exploring different income streams can help you discover your true passions. You may enjoy your side hustles more than your full-time job, and as you slowly increase the income earned from your secondary income source, you might be able to quit your full-time job one day and earn a living doing what you love.
Do you have multiple income streams? What will you start working on today?
