There are basically three types of income, described below:
Earned Income as defined by the IRS is all the taxable income and wages you get from working or from certain disability payments. For most people it is simply the money earned at a job while working for someone else. This is the type of income most are familiar with and the only source of income for many families. Also referred to as labor income.
Portfolio Income is the interest, dividends, and any other forms of payment received on the investments within your portfolio. Additionally, portfolio income includes capital gains, realized from trading instruments such as ETFs, stocks, bonds, mutual funds, currencies, commodities, etc. For most people, investing in the stock market is the most common form of building wealth and portfolio income.
Passive Income Also known as residual income, this is income that continues to be generated after the initial effort has been expended. It is the money you get from activities you performed in the past but are no longer required to do for an income (e.g. a pension from a previous job); the creation and selling of intellectual property (e.g. books, patents, or music); or assets that you have purchased (e.g. rental property, assuming the amount collected in rent exceeds the mortgage payment) from which you receive income.
This week’s SavvyPoll asks, “What do you believe is the best type of income?”
A. Earned Income
B. Portfolio Income
C. Passive Income
Along with your response, I am hopeful that you will comment on why you made your particular selection.
I was going to wait until tomorrow – Monday – to offer my own selection and comments; however, I will be pretty busy tomorrow and I’m not sure how often I will be able to check in on this post and we have established a good conversation, which I would like to keep going. Perhaps there will be something in my comments which provides more food for thought and conversation.
I’ll lead off my comment by noting that if forced to choose just one answer, I would choose ‘C’ passive income. Why passive? Deb hit on a key reason for me when she noted, “…although effort is put in initially in order to generate it, the effort can be exponentially smaller than the income generated in return.” Or looked at another way, the beauty of passive income is that the effort has already been expended; therefore, present and future resources (e.g. time and money) can be spent on generating income in the other two areas – earned and portfolio – or developing other sources of passive income.
With that being said, I recognize and appreciate that for most people, portfolio income will be the largest source of income in retirement. For the wife and I, it will be nearly a 50/50 split between passive and portfolio income. I touch on the topic in this recent post on multiple streams of income.
The difficult thing with passive income? generating it. While most of us will have the most familiar form of passive income later in life – a Social Security pension – as many employers do away with defined benefit plans, a once common form of passive income is becoming a lot less common.
Outside of pensions, another source of passive income is the creation and selling of intellectual property (e.g. books, patents, or music). Speaking from experience, a couple of self-published books, earning significant passive income in this way is difficult. While I consistently sell a few books a month, it certainly is not significant!
Another source of potential passive income…well really semi-passive income? Rental property. I say semi-passive because the bulk of the work is done in selecting and purchasing the property, while some work/time (e.g. maintenance) will likely be required during the ownership period. Of course, if a property management company is hired to deal with any issues, a rental property creeps a little closer to being completely passive. But of course, hiring a property management company means the income is reduced.
Of course, there isn’t really a correct answer. As astutely noted by Brad, Tyrell and Char, most of us start at ‘A’ earned income to build a foundation which makes portfolio and passive income possible.
Ideally, which a number of readers touched on – as did I in a post discussing the definition of wealth a while back – if you plan on retiring and not working at all, the more passive and portfolio income you have, the better.
On to the results…