If you’re looking for ways to increase your income, then it’s important to know about active income vs passive income streams. These are the two primary income sources that you can use to not only increase your income, but to also build wealth.
So, what is the difference between active income and passive income?
The main difference between active and passive income is how the money is earned. For active income, you must exchange your time and presence to earn money. Passive income can be earned without trading your time.
The truth is that you’ll need to employ both if you want to really make more money.
What is active income?
Like I explained earlier, active income is the income that is earned from trading your time for money. Also known as earned income, this form of income requires you to exchange a service for pay.
In essence, you must be present to make money.
Active income is typically the primary source of income for most people. If you work a 9-to-5 job or even a side hustle, your earnings are considered active income.
Although it requires you to trade your time in exchange for money, you can earn active income much more quickly than passive income.
For instance, if you need to make an extra $1,000 in a month to reach some financial goals, you can just work extra hours at your job. With active income, there is a very clear correlation between the money that you earn and the time that you work.
Also Read:
- 6 Passive Income Ideas That You Can Start for Free
- 7 Must-Have Streams of Income to Build Wealth
- 7 High Income Skills to Drastically Increase your Income
5 Examples of active income
1. A salary earned from your work
The salary that you earn from your job is considered active income. You receive a set amount of money per year in exchange for providing a service for your employer.
Salaries can vary by industry, but there are some high-income skills that you can develop to earn more in your career. You should always work to increase your salary by honing your skills and, ultimately, asking for a raise.
2. Hourly wages earned from your job
In some cases, you may earn an hourly wage for your job. This means that you’ll earn a set amount of money for each hour that you work.
Depending on your employer, you may also earn extra money when you work over your allotted hours for the week. Overtime means that your hourly wage is increased to compensate for the extra hours worked
Like a salary, you can always find ways to increase your hourly wages by improving and broadening your skillset.
3. Tips for a service
Another way to earn an active income is through tips. Servers at restaurants are notorious for earning a living from tips. In general, though, tips are commonplace in the service industry.
A tip is given in exchange for your service to a customer. Traditionally, the better service you offer, the more you can make in tips. Now, however, it is commonplace for businesses to include tips in their overall service charge to combat patrons who don’t tip.
Here are some ways that you can increase your tips!
4. Commission earned from sales
If you work in sales, you’re probably earning a commission from sales. This is an amount of money that is earned based on the number of sales that you make.
The more you sell, the more you’re able to make. Though in some cases you may earn a base salary and the commission is in addition to that income.
5. Income made from services
If you own a business, then you may also earn active income from offering services. For example, you can offer coaching and consulting services where clients pay you a set rate in exchange for your help.
In this case, your income wouldn’t be considered tips and you may not be working on an hourly rate. It’s simply income in exchange for your services. This is the case for all service-based businesses like hairstylists, barbers, etc.
Passive income meaning
Passive income is income that is earned passively, or without much effort. The phrase, “making money in your sleep” describes passive income. You literally don’t even have to be awake to earn passive income.
Despite the little effort that goes into earning passive income, the common misconception about passive income is that you don’t have to do any work. The truth is that you must put in work upfront in order to earn money passively.
So why exactly does that mean?
It means that you have to build up passive income streams over time and, in most cases, money. I’ll elaborate more on this in the passive income examples.
7 Passive income examples
1. Interest income from a bank account
Interest income is from your money-earning interest in a bank or interest that is paid back to you from money that you lend. It’s the epitome of your money earning money for you.
You must already have money in order to leverage this passive income source. This means that at some point, you would have earned money from an active income source first.
Nonetheless, this is an easy passive income stream because the most you have to do is deposit money into a savings account.
2. Dividend income from investing
A dividend is money paid out to stockholders by companies from their profits. Essentially, it’s your piece of the pie from your monetary investment in the company. The more shares that you hold in a dividend-paying stock, the more income you can make.
Again, in this instance, you’ll need money to get started investing in the stock market. The great news is that you can start small by investing and reinvest your dividends to earn more money.
3. Rental Income
Rental income is money that is earned from renting out your property—in most cases, a home or commercial property. If done strategically, the income is enough to cover the mortgage, maintenance, and optional property management costs, with enough left over for profit.
Getting into real estate investing can be a lucrative passive income source; however, it can also be quite risky. There is no guarantee that you’ll be able to rent your property, which could put you at financial risk.
Nonetheless, many millionaires have been made from real estate investing.
4. Royalty income from intellectual property
Did you know that you can earn royalty income?
This term is most often heard in the music industry—where artists are paid royalties for usage of the music. But you don’t have to be a musical artist to earn royalties. If you write a book and sell it on Amazon, for example, you’ll earn royalties from those sales.
Considering that you can write and publish a book for no money at all, this is one passive income source that does require much money to get started. The trade-off is mostly time.
So if you have time to create a marketable intellectual property, you can earn royalty income.
5. Affiliate Income
Affiliate income is another great example of passive income. In simple terms, it is earning money from referring someone to a product or service.
This means that you don’t even have to create a product or offer a service to make money. What’s even better is that you don’t have to invest any money to earn affiliate income.
I talk more about affiliate marketing in my post on how to make money blogging.
6. Income from advertising
Money earned from advertising is another form of passive income. This is more commonplace among bloggers and content creators.
In this instance, you earn money from advertisers placing ads on your website or YouTube channel.
Though it typically doesn’t cost anything to become a part of an advertising network, you still have to put in the leg work to build up a platform that advertisers want to be on. In the case of using advertising to make money on YouTube, you have to have at least 1,000 subscribers and 4,000 watch hours.
7. Income from digital product sales
One passive income source that I encourage everyone to build up is income from digital product sales. Unlike physical products, digital products allow you to sell without being present or even having to ship anything.
It’s the one type of product that doesn’t have inventory restraints or selling limits. You can literally sell as many digital products as you want and never run out.
With the right systems in place, you can deliver your products automatically and collect the money earned from it.
Active income vs passive income: Do you really need both?
As can see, you need active income in order to start making passive income. Unless by some rare chance you get a large inheritance or win the lottery, you’ll have to earn active income to fund your passive income streams.
Although you can stand to make substantial money with active income sources, the reality is that you’re limited by time. You can only be physically present one place at a time and there are only so many hours in a day. This means that trading your time for money is limited.
However, with passive income, you can bypass the restraints of time and earn money without being physically present. This means that you can have multiple streams of passive income alongside your active income sources to make more money.
So as you’re working to increase your income and build wealth, remember that having both active and passive income is ideal.
As Certified Financial Education Instructor (CFEI), she has been teaching personal finances to women & youth for over a decade.
Fo is an established writer and expert contributor on the topics of personal finance, budgeting, debt payoff, money mindset, saving, entrepreneurship, investing, motherhood, personal development, and more.