The 3 Types of Income
Work hard, get good grades. Get a job, work harder. Save money and retire. Sound familiar? This is what we’re taught in school and by society when we are young about what we’re supposed to do when we get older. Your income was determined by how many hours you put in within your chosen career field.
However, as we grow older and, hopefully, a little wiser, we discover that there are other ways to make some moola, and in turn, earn back some of that precious time of ours. I was vaguely this paradigm was shattered when I read Robert Kiyosaki’s Rich Dad Poor Dad. A new way of looking at earning was pulled into focus with his Cash Flow Quadrant.
In both books the simple lesson is; The rich don’t work for money. They make their money work for them.
Cash Flow Quadrant breaks down the four types of earners; wages, salary, investor, and business owner. The The earnings of the first two depend on how much work they put in while the latter two do not. Try make money even if they don’t show up to work. While they sleep. On Vacation! Here’s a quick definition of the three types of income to better explain how...
Earned Income
This is income paid in direct exchange for your labor. Yes, in Cash Flow Quadrant separates wage earners from salary earners. Wages are generally defined by hourly work. Salary is tied to more specialized work sometimes requiring a specific degree, license, or certificate and given an annual income paid out monthly. Jobs that pay wages are for the most part occupations that require less school or training and fewer skills than those paying salaries. Salary-paying careers often pay far better and in many cases such as doctors and attorneys for example make an excellent living.
The reason they are grouped together is for one very important reason. Both the FroYo clerk and the office manager will stop getting paid and undoubtedly fired if they stopped going into work. The other two forms of income usually take more effort to get going and the occasional maintenance, but will continue to pay you no matter if you take a sick day or take a month long vacation to the south of France.
Passive Income
This is income generated from assets you have previously invested or created. Some forms of passive income include:
Stocks, mutual funds, or REITs that pay dividends.
Owning rental property
Becoming a private lender
Affiliate marketing on blogs and websites
Owning a business
Passive income often takes a heavy investment in the beginning of time, education, effort, and capital to get started. The end result, though, is an asset that pays out even when you sleep!
Beyond gaining back some control over your time, passive income assets give you more control in general. You have more influence over how much you can earn with that added advantage of usually having lower tax liabilities than that of earned income.
Portfolio Income
Also know as Capital Gains Income, portfolio income is the income earned after selling an asset that has increased in value. there are many ways to do this such as selling off passive income assets at the top of a market cycle or the appreciated value outweighs the value of holding that asset.
Over time through growth of a business, rise of the market economy, and by inflation the value of a stock, bond, mutual fund, or real estate will increase. After which the owner may choose to sell.
Natural appreciation often is a slow process, taking years to realize potential gains. Real estate Fix and Flippers shorten the timeline from years to months and even weeks by buying dilapidated properties at a deep discount, forcing appreciation through renovation, and selling at the higher free Renovation Value or ARV.
Another method is something called arbitrage. This is when you buy something in one market and bring it to another market where buyers are paying more for it.This is done on the global scale with commodities as well as on the individual level with websites such as Poshmark, Amazon, and eBay.
there are exceptions such as Fixing and Flipping mentioned above, but for the most part, portfolio income will require less work than other forms of income.Notice that many types of assets can earn both passive and portfolio incomes. For example: a single family home with a tenant paying rent will appreciate over time. To use one of Kiyosaki’s favorite metaphors, Monopoly, earned income would be collecting $200 each time you rounded Go, portfolio income being when you buy a property and improving it with four green houses and a red hotel, and passive income is when your kid sister lands on that property. Muah ah ah!
It is not up to me which form of income is best or best for you. What is important that you know and become familiar with each. The wealthy have learned to use each to their advantage. Financial literacy is your key to financial and ultimately time freedom!