What are the differences between passive and active income?
This is an ongoing debate, and a hot one, amongst financial experts, and too many times, we confuse the two, and this confusion leads to bad business decisions (and all sorts of other types of decisions as well).
But what is a passive income, and what is an active one? Today, we’ll go over some of the differences between both of them.
And what will we be mentioning? Well, our discussion will cover both definitions, and ideas to earn either of them, so in essence, we’ll be mentioning:
- What is passive income?
- What is an active income?
- Do passive and active income overlap?
- Best ways to earn via passive and active income
By the end of this little article, you should have a clear grasp of what each terminology means, and I’m sure that you’ll be able to go out there and apply what you have learned today (or at least some of it).
Now, since the topic is rather sensitive (could be considered “your money your life” topics), let me just point out that I’m no financial advisor, and that you should do your due diligence when it comes to money.
Never trust anything I say. I’m only a messenger, and am just regurgitating the information that I’ve personally gathered from out there in the “interwebs”.
In fact, you should trust half of what you see and none of what you hear…
And to be honest, you should probably even question THAT statement (I think it was first mentioned in medieval times in London…so you know things were weird).
With that said…let’s check it out.
What Is Passive Income?
Passive income, can be defined as an income source that generates money, even if you have no active involvement.
Warren Buffet once said that “if you could not find a way to earn money while you sleep, you will work until you die”.
It sounds gloomy, but this is true, and most successful entrepreneurs and millionaires know that.
What many people misunderstand is that passive income “does not require work”. In today’s day and age, everything is “instant” (or close to it) and people seek instant gratification. If it takes too much work…it’s not worth doing. If it doesn’t give instant results, it’s not feasible…and so on.
But the truth is that everything takes work.
And making passive income, takes work too. It takes work in the beginning, and pays off long term.
Also, many people think that passive income is not taxable—it is.
Like we were mentioning, before a source of passive income yields money, you need to do a little work. Sometimes…even a LOT of work. I know I had to.
An example is an investment in the stock market. You cannot blindly invest in stocks without going through any sort of stock analysis, have experience or know what you’re doing.
Another example is rental properties. You need to know the numbers, the apartment, the neighborhood, choosing the right tenants and a ton of other stuff, before you can ask for rent and lay back to reap the rewards. And even if you already have tenants, you need to manage the apartment complex or get some to do it for you.
Here are some of the most common sources of passive income:
- Properties for rent, where you rent out a property to people.
- Online income-generating properties. Like websites, e-commerce sites and the likes. As long as they’re cash flow positive and you can outsource the work, they could be “considered passive”.
- Dividend stocks. You invest your money in a company that yields a good percentage return on your money.
- Peer-to-peer lending. Similar to dividends stock…this is basically where you make your money available to someone, and make interest on the money. Kind of like what the banks do, you know?
- Other investments. You invest money in a business venture, but you have no direct participation in its operations.
- Other stuff like: Digital assets, digital courses, books, royalties, customer email lists, etc.
What Is An Active Income?
An active income, on the other hand, refers to a source of money where you have active and direct participation or involvement in.
The most common source of active income is employment, and unfortunately, it feels like most people in this bracket, are unaware of the other bracket.
Here are some examples of what is considered active income:
- Professions – doctors, lawyers, engineers.
- Employees – those who work fulltime jobs.
- Freelancers – those who do not earn money unless they provide a service.
- Businesses – any person or entity that provides services or products to earn money.
In the United States, the Internal Revenue Service or IRS has a clear definition of how to classify if an income source is considered “active” versus passive. It is called “material participation”.
Here are the rules to know whether or not it’s material participation:
- If you spent more than 500 hours in building the business, or at least ten weeks of 40-hour workweeks, then it is material participation.
- If you spent at least 100 hours in the business, and that is basically how much other business partners spent, then that is also considered material participation
In short, any income where you have a direct involvement is an active income. This includes tips from customers, profit from products you created, commissions, and many more.
As you can see, the confusion stems from some situations when a person earns money while he sleeps, and yet he had active participation in growing the business.
For example, you may earn money from your networking commissions—sales made from the effort of your downlines. Technically, this is an active income because you also did the work, plus you have to meet your team on a regular basis.
Do Passive And Active Income Overlap?
Yes, they do. But of course, the government does not recognize this overlap. For the purposes of this tutorial, we will recognize that in many cases, passive and active income overlap.
In this case, I prefer to call the income source as semi-passive.
In a semi-passive income, you have to build your business first, and then you can earn from it later.
It will generate revenue, even if you are asleep, but if you stop working on it…the revenue is also likely go down.
I mean this is pretty obvious, right?
Things change all the time, and if you stop nurturing the business, just like you would anything else…it’ll slowly die down on you.
However, this decline in revenue is not always in direct proportion to the work you put in, (it might go down a bit though). Also, the amount of money you earn…does not necessarily come in direct proportion to the effort you put in either (which is why a lot of people give up).
In an active income, you get paid by the hour, and not necessarily for your output (you’ll not necessarily earn more if you work harder, you might get a raise, but that’s about it) In a semi-passive income, it does not work this way.
A good example is blogging.
You need to put in a lot of hard work in your blog, but you do not get paid every time you post something new.
In the case of my blog, I didn’t make any money, for the first 8 months of the blog. How many people do you think would work for 8 months “for free”? I don’t think that many would.
The money you earn will come later through ads, info products, affiliate marketing, guest posting etc. If you stop blogging, it does not mean that the revenue stops abruptly—it only means that your income may decline over time.
As you can see, it is a combination of active and passive participation. You can earn from ad revenue even if you do not blog for a month, but you will not earn anything if you abandon your blog (you’ll also likely not make much MORE money than you previously had either).
Best Ways To Earn Via Passive And Active Income
Alright, so now let’s get into some of the ways you can go about creating income, both passively and actively.
I think it’s obvious, that you’ll want to try to find a way where you can at least have a few passive or semi-passive sources or streams of income, throughout your career. This will allow you to free up more time, since your income won’t be tied to just one activity, but will be building and compounding.
Regardless, if you don’t start earning income actively first, you’ll have a hard time actually creating a passive source of income, so we’ll talk about some good ways of making those as well.
Best ways to earn a passive income:
- YouTube – create a channel on YouTube and grow your subscribers. Once you are eligible for revenue sharing, YouTube will allow you to show ads and share the revenue from those ads. It’s also great to build a brand an you can sell products for a commission too. Youtue is a goldmine, and it’s free.
- Blogging – Create a blog and post content regularly. Even though written content, I’d say is not as powerful as video anymore, you can still make a pretty decent amount of money off it. You can earn via ads, affiliate marketing and
- Online Courses – you can build courses and sell them on platforms like Skillshare and Coursera; you share the earnings with the platform, or you can use something like GrooveSell where you can sell your course, without having to pay any fees (and it’s free).
- Stocks and other investments – you can invest your money in the stock market, or crypto-currency (the latter being a bit more…speculative). As always, these types of investments are volatile, and you should understand the risk before you invest, but it’s a really easy and cool way to start having your money work for you.
Here are some active income ideas:
Even though I could write some random profession, as a good active income generating activity, I think that would be a bit too boring, so instead, let’s focus on stuff that you can do online too (plus, a lot of people are working online now more than ever).
- VA – be a virtual assistant and do office tasks that can be done remotely. You can actually work independently of location, which means that you can travel and work from wherever you want!
- Copywriting – This is a very high income generating skill if you’re good enough. It does take a lot of time to get good at, but there are resources out there that can teach you how to become amazing. This is a great option if you like writing.
- Social media management – create social media content and grow your client follower count. Handle their social media profiles, become a community manager, do customer support, schedule posting, media and content.
- Arts – Do animation or graphic arts; create business cards or edit people’s photos, create posts and media for clients, create Pinterest pins, Instagram stories and so on. Basically, this is more “in the trenches” and hands-on work.
As you can see, all these examples require that you work. You either get paid by the hour, or you charge your clients per project. When it comes to jobs online though, be careful and make sure you avoid the top scams when you try to make money online. You want to make sure you’re safe at all costs.
There is no right or wrong choice between choosing passive or active income-generating strategies. We need people doing both, and at the end of the day, it’ll all boil down to what you decide to do, what you resonate more with, and your strengths and weaknesses.
At best, you can for sure try doing both while you are young, which will allow you to increase your earning potential a lot, and you can invest your savings in passive income sources when you’re a bit older (not financial advice but I wish I had done this).
This does not mean that it is already too late for older people. There are many ways to invest in passive income streams, especially today when the internet makes everything possible.
Choose a passive income source, study what you can, and make your investment slowly but surely. Scale-up once you see growth, but never put all your eggs in one basket!