Passive Income Vs. Active Income (A Beginner’s Guide)

By Zach Buchenau

Last Updated: January 13, 2021

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Passive Income vs. Active Income: What's The Difference? A Beginner's Guide | Be The Budget

No matter how you make an income, the money you make will fall into two categories: passive income, or active income. And while you may have heard these two terms in the past, many people don’t quite understand the difference. So, without getting much further into this post, I want to answer the obvious question: what’s the difference between passive income and active income?

Passive income is money earned on an investment, or work completed in the past, that continues to make money without any additional effort. Active income, on the other hand, is money earned in exchange for performing a service. For example, hourly wages, salaries, commissions and tips, are all examples of active income.

So, which form of income is better? Well, we have a lot to cover before I can answer that.

In this guide, I’m going to take a deep dive into active and passive income. My goal for this article is to not only help you understand the difference between these two forms of income, but to also equip you with a few examples that you can incorporate into your own financial life.

So, if you’re ready, let’s get started!

Passive Income (Explained)

I have heard passive income called the holy grail of income streams, and it’s pretty easy to understand why. I mean, think about it. If someone told you that you could put in some upfront effort into something that will generate income for years, or even decades to come, would you honestly say no to that? Well that is the idea behind passive income.

If you are willing to put in the work early on, passive income could sustain your lifestyle for a really long time. The good news is that these days, there are all sorts of ways to generate passive income.

Though, I think it’s important to preface this section with one very important statement: passive income still requires work. In fact, oftentimes, the upfront work required to generate passive income can take years. But, if you focus your effort on something that will eventually generate money while you sleep, then the juice may be worth the squeeze.

So, what are some ways you can make passive income? Well, that’s exactly what I’m about to cover.

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5 Examples Of Passive Income

1. Interest Earned From Investments

Earning interest on investments is the original, and most powerful form of passive income. In fact, this is why contributing to a retirement account is so important throughout your career. If you can build up enough money in investments, you can live off the interest for the rest of your life.

For example, if you were to invest consistently, and aggressively enough to build up $5 million in your retirement portfolio, then your annual income — if you lived off the interest, alone — would be $500,000 at a 10% return. That’s a bigger income than most people ever dream about. And you wouldn’t have to put in an ounce of extra effort in order to earn it.

All that money would be a result of your disciplined investing throughout your life.

That’s a retirement lifestyle I can get behind.

2. Affiliate Income

Affiliate income, it’s basically just money you receive as a referral commission when users click-through a specially-coded link on your website, and make a purchase. Thousands of companies offer affiliate commissions for their products or services, so the opportunities are endless here.

This is also one of the best ways to make money from a blog. If you build a large blog audience online, and monetize your site with relevant affiliate links, you can generate large amounts of affiliate income. And honestly, many people do.

3. Display Advertising

Another form of passive income is display advertising. This is along the same lines as affiliate income, because you need to have a website or blog that gets a large amount of monthly traffic in order to earn money this way. That said, if you put in the work to build a website that gets tens of thousands or even hundreds of thousands of monthly pageviews, then you could make a great passive living with display ads.

Remember how I said that some forms of passive income can take years of work in order to generate significant revenue? Well, this is one of them.

4. Rental Income

If you have the money to buy a rental property, you could spend years pulling in monthly rent checks as passive income. Now, this is one of the higher-risk forms of passive income, because it requires a large upfront investment, and if you can’t find a tenant to pay you rent, then you won’t make any money. The other thing about rental income, is that you have to maintain the property; which, at times, can make rental income feel more like active income.

5. Online Course Sales And Info Products

If you haven’t noticed, I like digital forms of passive income. We’ve already discussed affiliate marketing and display advertising, but the big winner for online passive income is course sales and info products.

In fact, many people make six -figures, or even seven-figures a year from this passive income stream, alone. The key to this, once again, is to build a large online audience — which, yes, can take years. But, if you have an audience, and you launch a course that teaches a valuable skill, then you could easily make tens of thousands of dollars per month.

Why Is Passive Income Important?

Passive income is important because your physical presence and effort isn’t continually required in order to make money. In essence, if you have a passive income stream, you can make money at all hours of the day, and every day of the year. So, whether you are sleeping, on vacation, or watching tv, you can still be making passive income.

But, here’s the thing, passive income, in most cases, takes years to build. Whether you are investing, building an online audience though a blog, or saving up the cash to buy a rental property, there is a lot of early — active — work that goes into generating passive income. You can’t just be lazy and expect passive income to start rolling in. But if you are willing to put in that kind of effort, you could end up literally making money while you sleep. And that’s the goal of passive income.

Passive Income vs active income (A Beginner's Guide) | Be The Budget

Active Income (Explained)

If you’ve ever earned a salary or hourly wage, then you have earned an active income. And while active income might not be called the holy grail of income streams, it is still extremely important. I already talked about passive income taking a long time (and a lot of upfront effort) to build. So, if it weren’t for active income, many people would never have the opportunity to build passive income.

Think about it, if you want to earn passive income from investments, then you need to first invest the money you earn from your active income stream. Or, if you want to build a blog with a big enough audience that you make money through affiliate marketing, display advertising, or online course sales, then you need to work hard to make active income in order to sustain your life while you build it.

In most cases, passive income wouldn’t come to fruition without first earning active income. Sure, active income won’t make you money while you sleep. What it will do, however, is pay for the bed you sleep on while you work to build your passive income.

5 Examples Of Active Income

1. Salary

If you go to work at 8 in the morning, and leave at 5 at night, and make a set salary for your efforts, you are earning an active income. Essentially, you are trading a year worth of your time and skill-set in exchange for a set amount of money.

2. Hourly Wage

Of all the forms of income, the hourly wage is probably the most common. You can make an hourly wage as a teenager delivering pizzas, or as a full-time job as an adult. You could even make an hourly wage as a side hustle at night.

One of the best benefits of this form of income, is that oftentimes, it comes with the opportunity to make overtime.

3. Commissions

If you are in sales, then any commissions you make are a form of active income. And, of all the active income streams, this one has the most potential to make you a significant amount of money.

A good example of this would be real estate agents. When a real estate agent sells a home, they make a set commission. So, if they sell a $500,000 home, and make 3%, then they just earned $15,000.

4. Tips

There are many jobs out there that offer the opportunity to make tips. From serving at a restaurant, to delivering furniture, to caddying at a country club, whenever you earn a tip, you are making an active income.

5. Consulting And Freelance Services

Consulting and freelance services are two of the best ways to make an active income. So, if you have a marketable skill set, or you can help a company improve an area of their business and generate more revenue, then you should consider this.

For example, if you are a great photographer, videographer, web developer, graphic designer, or writer, then you could start a freelance business offering those services to clients.

On the other hand, if you have a deep understanding of digital marketing, social media, logistics, or business operations, you could offer consulting services to companies that need help in your area of expertise. Many consultants make an unbelievable living with this active form of income.

Why Is Active Income Important?

Active income is important, because it allows you to earn an income quickly and consistently. Unlike passive income, that can take years to build, active income offers you the opportunity to make money in a short period of time. Additionally, more often than not, active income provides people with the means to build a passive income.

Which Is Better: Active Income Or Passive Income?

Let’s be honest, passive income is better than active income. Think about it, if you have a passive income stream that generates money for you when you aren’t working, then you can take a vacation and come home to a bigger bank account. You can fall asleep, and make money while you dream. Pretty awesome!

That said, active income is, more often than not, the foundation for you to make passive income, so don’t dismiss it. Whether you want to make money from investments, a blog, or anything else, you need to earn an income while you build your passive income streams. So, active income plays an extremely important role.

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What's the difference between passive and active income? | Be The Budget

Zach Buchenau

About The Author:

Zach Buchenau is a self-proclaimed personal finance nerd. When he isn't writing about budgeting, getting out of debt, making extra money, and living a frugal life, you can find him building furniture, fly fishing, or developing websites. He is the co-founder of BeTheBudget, and Chipotle's most loyal customer.

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