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 wished I knew earlier different ways to make money that didn’t require me to exchange more of my time for cash.
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 wellbeing.
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 paid salary or hourly. In contrast, others may get income from other activities such as business activities, rental properties, or investments in stocks. You can think of any money that comes into your life subject to taxes as a type of income.
Why is it important to know the types, sources, and streams of income?
The more you understand how income is generated, the less you feel constrained about earning money only through exchanging time or skills. When you understand the various types of income, you can make better decisions that build real wealth that includes financial gains and more free time. Knowing the types of income can help you understand the following:
- 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
3 Types of Income
Oftentimes, it’s helpful to categorize income into three types. This method labels income as active, passive, and portfolio.
Active income is referred to as Earned Income by the IRS. This means your exchanging your time, skills, and energy for money. It’s active and material participation in business activity. As noted, you receive a paycheck or 1099 form for wages, salaries, commissions, and tips earned.
For example, you have active and earned income if you work as a salaried accountant or an hourly barista. Other examples include roles in management, customer service, sales representative, freelancer, teaching, construction, etc.
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.
You can learn more about the differences between active income and passive income here.
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 company stock that pays a quarterly dividend, or you lend money to friends or financial institutions (savings) and earn interest, or you sell a stock that appreciated from $10 to $15 for a capital gain of $5. Portfolio income is often associated with long-term goals such as retirement but isn’t limited to such.
Some examples of portfolio income include becoming a company’s stockholder, depositing money into a savings account or certificate of deposit (CDs), invested in index funds and ETFs.
When creating your income strategy, it’s important to understand how taxes are applied. The IRS tax rates can differ significantly depending on the type of income made with portfolio income often lower than active income.
7 Streams of Income
Another way of thinking about income is through income streams. There are 7 types and include:
1. Earned Income – it’s earned from your job, whether it’s salary or hourly. Earned income includes your paycheck from your day job, and income made driving for Uber. It’s anytime you’re exchanging your time, energy, or skills for money. The number of hours you can earn money is limited.
2. Rental Income – 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 rental income is a great source of their wealth.
3. Profit Income – often referenced as business income, is when you make money through a business. However, you’re not running the day-to-day operations or involved in the decision-making. You invested capital and paid through profit sharing.
4. Royalty Income – money 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 by a business or end-user.
The following three income streams fall in the portfolio income category.
5. Interest Income – money 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.
6. 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.
7. Capital Gains – money made when you sell your assets. Whenever you sell any assets that you have appreciated, you have capital gains. This includes the sale of stocks that have risen in value or homes that have appreciated.
What’s the difference between income streams and income sources
We’re going to get a bit granular, but it’s important to understand the differences between income streams and incomes sources. For example, if you have a full-time job and a side hustle delivering for Instacart, you have 2 sources of income in one income stream. It’s still active income considered as earned income by the IRS.
Or if you’re in a relationship, both you and your partner work a 9-5 job, then you have 2 sources of income. Now, if you also have a rental property and invest in dividend-paying stocks, then your household has 4 sources of income in 3 income streams (earned, rental, and dividend).
Knowing the difference can help you create an income strategy where you’re less dependent on earned income.
Why Diversify and Multiply Income
Everyone can benefit from diversifying and multiplying their income. This increases your financial independence and peace of mind.
I want you to start thinking about income strategy.
First, focus on increasing your primary salary earned from work (read this to get a pay raise). Second, it may also be easier to earn extra money doing side hustles like driving or freelancing. Third, you might want to formalize a business with that side gig. And finally, the extra income earned can buy a rental property and invest in the stock market. You see where I am going with this scenario.
How Multiple Income Streams Supports Financial Wellbeing
For greater peace of mind, it’s best to have diversified and multiple income streams. The following is why you need to have multiple incomes coming into your life.
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.
With a second income source, you’ll be better prepared to survive a layoff or job loss. Between your severance, unemployment checks, and a secondary income source, you might be able to keep your head above water until you find another full-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 cash reserve 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 savings account.
Start an emergency fund with your current financial institution. Change the title to reflect rainy day fund or opportunity fund. Consider opening a savings account with another institution if you feel tempted to dip into the funds for discretionary spending.
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 a few days each week, the extra money can go toward paying down your debt, which ultimately frees up your money and can improve your credit score.
Have a debt repayment strategy to help you pay off debt faster. Consolidate your credit card debt into one loan and refinance your student loans to save money and shorten debt repayment.
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.
Having 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 get a better picture of 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 budget apps to keep you on track and monitor your progress with less effort. Find the best budgeting app to help you.
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.
Ideas to Diversify and Multiply Your Income
Read the following articles to help you get started: