Sharing Daily Discoveries About Personal Finance And Business Topics

Passive Income, Residual Income and Linear Income

When it comes to making money and earning an income, as with most things I think it is important that you first try to educate yourself about your options and what they really mean. For most people when they think income they think of linear types of income such as say getting a job or selling belongings. A working professional would usually fall into a linear income category too as in these cases you have to continually work in order to get paid. It usually stops there for most people as those are the only ways that they have been taught in terms of how to generate money. When you tell them there are different types of income they just give you a blank stare.

Residual income is in my opinion an important factor for one’s long term financial success. Residual income is basically being able to earn money from some type of work or investment that you have done once and still continually get paid for it. A quick example would be say an actor who stars on a popular sitcom where he/she gets paid a certain amount to work on one episode. On top of this, whenever a rerun of that same episode occurs the actor will continually be compensated for that as well which would be residual income.

Another way to plant the idea of residual income is to think of all of the things that you continuously pay for and how companies make money off you with that one time effort. I’m pretty positive that most people reading this have subscribed to some kind of Internet access service to do so. You can consider yourself as residual income for your provider as they did the work once to attract you in using its service and now you pay them every month for its service.

Passive income is a little trickier as many people describe it as almost exactly the same thing as residual income. I personally describe passive income as where you continually generate money from a source/investment which does not require direct involvement from yourself. So an example could be say a business that I initially started and now that I have all of the necessary talent and structure in place the business is self functional where I don’t even have to be there for it to continually expand into new areas and generate revenue. As you can tell, a passive income is usually the more difficult type of income to establish.

There are probably a bunch of different definitions for of all of these depending on who you talk to, but I think the important thing is to recognize that there are different types of income and the more you educate and understand it in general the better you’ll be in recognizing the different opportunities that are out there.




7 Comments to Passive Income, Residual Income and Linear Income

  • Investment income from securities like stocks, bonds, and mutual funds are an important source of passive income. I have been investing for 15 years, and a full 1/4 of my total accumulated wealth at this point has come from investment income (capital gains + interest + dividends).

    joewatch 4/7/2007 6:57 am
  • Joewatch,

    It’s interesting that you mention about stocks and investment as I often see a lot of people debate on whether or not that is considered as passive income. Rather, they are more technical where income derived from say a stock or dividend would be classified as “Portfolio Income”. I think the argument is that you are constantly monitoring how well or bad the stock is doing to know when to buy and sell which means you are actively involved in it and so it is not really a passive activity. A little confusing I must say, but is an interesting tidbit I thought.

    Alan Yu 4/7/2007 11:34 am
  • There is one thing that adds to the confusion about stocks and bonds, and maybe this is what you mean.

    Some people when they talk about “investing” mean that they actively buy and sell stocks. They monitor prices every day and read news about the companies, which guides them about their decision whether to buy or sell. Maybe they are really know what they are doing and are able to valuate the company with reasonable accuracy. For example you think MSFT is worth $35 a share based on your calculations, but it is only selling for $28 per share. So, using this information, you would buy 1000 shares. If the price went up to $35, that would be your signal that it was properly valued, and you would then sell all of your shares.

    However, there is another way to think about investing when it comes to stocks and bonds. And this is the way I think about it, which is why I consider it to be passive income.

    Buying a stock is buying part ownership in a company. A company like Microsoft has a money-making (profitable) business. If I buy a share of MSFT, I get to share in that profit. Some of the profit might get passed directly to me as a dividend. Some of it might be held within the company, in which case I would see the profit as a capital gain (increase in share price). But I would never consider selling the stock just because the price went up from $28 to $35. The only reason I would consider selling the stock would be because I didn’t think MSFT was going to be profitable anymore.

    Of course there are some considerations that you have to take when you buy the stock in the first place. For example, a company you are investing in might be profitable, but only making a 5% return on capital. In this case, you would be better putting the money in a savings account that pays 5% interest, which is totally riskless.

    I know you’ve read Robert Kiyosaki’s books, which basically slams mutual funds, say they are for the “sucker” middle-class. But mutual funds are a good way to invest because you are basically paying somebody with a proven track record (if you are buying the right fund) a reasonable fee to identify good, profitable companies for you to invest in. So for somebody who is using stocks and bonds as passive income, it would not be unusual for you to buy a mutual fund and basically hold on to it forever.

    joewatch 4/8/2007 8:31 am
  • What you wrote makes sense. Trying to think of examples in regards to why some people would think otherwise, one of the reasons I kind of recollect was that someone said that by investing in the company in that way you are also an active participant in the company with things such as having voting power which you can exercise. I quickly did a search though and found these two links:

    Wikipedia

    Investopedia

    Unfortunately, they don’t really say why it is not considered as passive income with examples but rather just say that it isn’t.

    I’ve actually only read one of Robert Kiyosaki’s book, which I blogged about every chapter, and it was more out of curiosity and trying something new since I don’t usually read those kinds of books. When it comes to things like a mutual fund, I personally never invested in one and so I can’t sit here and say why it is good or bad as my basis would be based entirely on opinions and documentations.

    For myself, I like to be pro active in developing an income stream and then finding ways to say leverage it as I believe that is one of the most important factors in generating wealth.

    Alan Yu 4/8/2007 8:45 pm
  • OK, I think this clears it up a lot. Basically, portfolio income is a definition that the IRS created:

    http://www.irs.gov/businesses/small/article/0,,id=146330,00.html

    So buying a share of stock makes you part owner of a business, but for tax purposes, the IRS doesn’t see it that way.

    Is passive income necessarily better than portfolio income? I don’t think so.

    One example is comparying buying shares in a REIT (for portfolio income) vs. buying rental property (for passive income).

    http://www.bailard.com/pdf/Public%20vs%20Private%20Real%20Estate_.pdf

    joewatch 4/9/2007 6:28 am
  • Lot’s of insightful information there. Thanks for posting it. Kind of makes me want to learn more about investing in detail. I personally don’t think one type of income is necessarily better than the other as that is very dependent on the person and the lifestyle that they want too I’d say. If we were just comparing them from a dollar figure, there are lots of people who earn 7 figures in linear income as well for example.

    I guess for most people it comes down to risk and everyone considers different things as too risky. In most cases, I think it is due to a lack of knowledge or real understanding for something.

    Alan Yu 4/9/2007 11:20 pm
  • Most people fail at building a strong residual income because they neither have the patience or the funds to withstand months of no income while paying out hundreds of dollars monthly for product and advertising. The people who are successful use “funded proposals”.
    They make upfront money promoting a product and then backend the opportunity

    joe 6/25/2007 11:59 am

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