The Difference Between Active and Passive Income (And How to Leverage Both for Wealth Creation)

The Difference Between Active and Passive Income

Oh yes, there is a difference. Aside from dictionary definitions, the two makes great difference. From each other, and for your wealth.

You may already know there is a difference and you may know generally what that difference is, but it’s likely you don’t truly grasp the implications of those differences.

Leveraging both active and passive income sources is a great formula for wealth creation. It’s very seldom that one becomes rich from mere active income alone; it’s always a combo.

Unfortunately, not many know about leveraging the benefits of passive income. For starters, they don’t know what leveraging passive income means to begin with!

So, in this article we will talk about the real differences between these two sources of income and see how we can help you leverage both.

The Difference Between Active vs. Passive Income

According to Investopedia, very investor’s go-to resource online,  the definitions of active income and passive income are as follows:

Active Income –  Income for which services have been performed. This includes wages, tips, salaries, commissions and income from businesses in which there is material participation.

Passive Income –  Earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not actively involved.

Investopedia goes on to explain that passive income does not include earnings from “active business participation”.

Here’s what it actual means for lay persons like us:

Active income means you are doing something in order to receive that income. Some kind of work. Some kind of effort. You are not hands-off. You have to exert some kind of energy and time towards earning that income.

Passive income means you are earning regular income with little to no effort required to keep it coming. You are for the most part hands-off.

Source of Income vs. Your Goals

Why does it matter which one you are earning if it’s all income?

Of course it matters. Every good investor knows it is important to understand HOW income comes in and how much effort they need to exert for it to flow.

What is the most common reason investors give as to why they are getting into real estate investing or why they are already in it? Financial freedom.

Those who want financial freedom very clearly define that goal as being able to use real estate as a vehicle to eventually break loose of their current career and not have to work for their income.

In theory, and keeping it at the highest most basic level, financial freedom means you have to do no work in order to receive income. So once you are financially free, you no longer have to worry about money.

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Isn’t that wonderful? For me, it is.

For me, it looks like traveling, taking up new hobbies, taking random college courses to learn new things (for fun, not because I have to), skinny-dipping somewhere in the Pacific or the Caribbean, and playing in the woods, and as always, sleeping in — of course, without having to worry about money!

There is a term both of these plans fall under. It’s called “lifestyle design”. Y

ou get to design your life exactly the way you want it.

Isn’t that the point of financial freedom?

If you don’t care about lifestyle design, you can just stay at your current job, right?

With financial freedom, you can do whatever you want.

You can actually start forming lifestyle design before you are financially free too, just like I have. Even though I spend the majority of my time working on my company, I have positioned myself to be completely on my own schedule, I work whenever I want to for as much or as little time as I want, and I study, pursuing my graduate studies (and still having fun on the sidelines, as of writing, I am watching “How to Surf” because I’m going out this weekend to Central Luzon in the Philippines to learn surfing!).

I wanted these freedoms so I began pursuing a means to have those, which in my case ended up being starting my own company that I could work from anywhere and with no deadlines whatsoever (although the no deadline thing does make things hard sometimes).

The income from that company is planned to continue buying more passive income investments so eventually I hit total financial freedom where I can keep living my current lifestyle minus the work part. All of this is called “lifestyle design.”

Just to recall:

Investing – leads to – Financial Freedom – leads to – Lifestyle Design

Do you remember which kind of income requires you to work for it? Active income.

So then for complete lifestyle design, do you want to have to rely on any active income? No. You only want passive income because passive income doesn’t require much, if any, work on your part. Then you are free to travel or play or watch TV all you want.

Now you know you don’t want to deal with any active income, but what investing methods are considered active?

Active vs. Passive Investment Methods

Active Income Investments: Flipping and wholesaling. You have to do work in order to see money from these. You have to be hands-on.

Note: It is possible, if you are really slick and good, that you could be decently hands-off for a flip. But that is long down the road of being an advanced flipper so for now, I’m leaving it here.

Passive Income Investments: Rental properties and paper/notes. If done correctly, both of these will provide you with earnings regardless of whether you are hands-on or off.

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The Real Difference

Active income investing is, while it still may be an actual investment, a job. It is a J-O-B. So many people don’t see it like that, but that is what it is. Flipping houses is a job. Wholesaling is most definitely a job. Heck, landlording a rental property is a job.

This is important to understand this because it is a difference of how you spend your time. No-joke big-time investors make money in their sleep without putting in any effort because they invest in passive income investments.

If you are putting in effort, while you might be making bank and doing great at it, you are working. You are making a lot of income because you are rocking out a J-O-B. The no-joke big-time investors, if you’ll notice, also put in a lot of effort but their effort is not on what is currently making them income, it is on finding the next thing that will provide them more income!

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If you like the “job” of wholesaling or flipping or landlording, or whatever it is you may be doing actively to earn income, rock on with it. Especially if you are using the income from that job to buy passive investments with, which is how one really becomes successful- find ways to fund buying passive investments that will lead you towards financial freedom.

On that note too though, you can work any job or build a business to earn income that you can use to invest in passive investments. It doesn’t have to be flipping or wholesaling or landlording, albeit you do learn a lot about investing working those jobs, but it can be any job you want totally outside of real estate if you want it to be.

Real estate is just a great way to earn some fat cash, which is why so many people stick with it. And if you do that, you are awesome still, as long as you realize you are working a job.

It all comes down to your goals. There is nothing wrong with flipping, wholesaling or landlording, as long as you are understanding of the fact, and okay with the fact, that you are working for your money. You can do whatever you want, but at least be clear on what it is you are actually doing, i.e. working for your money versus investing your money.

Sources

Lifehacker.com. (2017). [online] Available at: http://lifehacker.com/why-passive-income-is-worth-more-than-active-income-1698928192 [Accessed 21 May 2017].

Staff, I. (2003). Passive Income. [online] Investopedia. Available at: http://www.investopedia.com/terms/p/passiveincome.asp [Accessed 21 May 2017].

Staff, I. (2003). Active Income. [online] Investopedia. Available at: http://www.investopedia.com/terms/a/activeincome.asp [Accessed 21 May 2017].

Project Life Mastery. (2016). Active Income vs. Passive Income: Are You Working For The Wrong Income?. [online] Available at: http://projectlifemastery.com/active-income-vs-passive-income/ [Accessed 21 May 2017].

Money Buffalo. (2015). Difference Between Active and Passive Income – Money Buffalo. [online] Available at: https://moneybuffalo.com/difference-between-active-and-passive-income [Accessed 21 May 2017].

Marquit, M. (2011). Active Income vs. Passive Income. [online] Everything Finance. Available at: http://everythingfinanceblog.com/663/personal-finance-101-active-income-vs-passive-income.html [Accessed 21 May 2017].

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