Passive Income Vs. Active Income {2021 Beginner’s Guide}

When you want to make money, there are two main categories: passive and active income. You’ve probably heard these two things mentioned before, but what is passive income vs. active income? Do they really create wealth? Is one better than the other?

This guide for passive income vs. active income will give you an understanding of what each type is. You’ll also learn how to make both types work for you and find out if there’s one of them you should rely on more than the other.

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What is Active Income?

Active income refers to money that you earn by doing something that requires immediate participation, as the name implies.

It comes in many forms. For example, you make active income from your job when you receive a paycheck for time worked. Active income also includes selling a product, service-based businesses, and anything that exchanges work for money. 

Typically, most people will either not be able to or will not want to work for active income forever. It is best suited for times in your life where you have the most energy, as it requires a constant exchange of services for money.

This is one of the main differences between passive income vs. active income. A lot of business and company jobs fall into the active income category, including hourly work.

What Are Examples of Active Income?

  • Wages. When you work a job, either by the hour or by salary, you receive an income regularly in exchange for the work you did. But making money requires that you continue to go to work and are there for an agreed-upon number of hours.
  • Tips. If you are in an industry that allows tipping, you can make active income this way, too. Tips are usually based on merit, which means with hard work, you might make more money. 
  • Commissions. If you sell a product for someone else, you can make a commission. This means a percentage of the sale for the item will be yours. Many sales-based jobs operate in this fashion.
  • Services. There are many jobs in the service industry, including accounting, consulting, construction, and more. The basic idea is that service jobs don’t sell a product; they sell expertise or advice. Most things that aren’t an exchange of goods are services.

What is Passive Income?

Passive income refers to money made without needing to do constant work to receive payment.

A common misunderstanding about passive income is that it requires no work. This is not true. Instead, it requires upfront work when you set up the income source but then requires very little on a daily basis.

What Are Examples of Passive Income?

Check out these examples to understand how passive income vs. active income works.

  • Rental Income. If you own property such as a house, office building, or apartment, you can rent it out and make an income from it. This is passive because you find a renter, sign paperwork, and receive a payment each month without needing to do much, except probably some maintenance from time to time. Rental income can be a great resource, especially if you own the property free and clear. No mortgage means higher profits. 
  • Affiliate Marketing. This is when you market a product or service through your business for someone else. For example, if you own a blog and include links to products you recommend, and someone who visits your site buys something, you make affiliate income, or a commission, from the sale. Many people have great success with this over time, although it can take a while to see significant results.
  • Advertise On Your Car. Sometimes you can use your car as an advertisement for a company. There are requirements you have to meet, but it can be a great resource if you do. Once you place the ad, you can begin to earn money. Different companies pay different amounts.
  • Create An App Or Product To Sell. If you’re creative or great with technology, you might consider making your own product to sell or setting up an app. When people buy your product, you make money from the sale. It requires effort to create the product, but it’s all set for continual sales after it’s up and running.
  • Blogging. This is an excellent resource for passive income. With blogging, you generally make money through ads and affiliate marketing. You drive traffic to your blog by creating content and marketing it. From there, you make ad and affiliate marketing revenue as people read the blog and click on links. Blogging is only semi-passive because you do need to create content and let others know about it. However, you don’t have to write as much as you’d think, maybe weekly, and once you write a blog post, you can still make money from it years later. If you’re interested, you can follow my free guide here.
  • Write A Book or E-Book. This is a fun way to make passive income. Write about something you care about, then put it up for sale. There are a lot of ways to sell e-books now, including your own website. When people buy a book, you make money. This can continue pretty much forever unless you stop selling the book.
  • Create A Course To Sell. This requires a substantial up-front time investment, but it can be well worth it! Creating a course involves being an expert on a subject, writing up course material, making videos, and more. But once you create the course, you can make a consistent income if it becomes popular. You may need to do updates now and again, but this is a great passive income source.
  • Become a silent business partner. If you have some money saved up, it’s a good idea to research start-up companies that need funding. If you find one you believe in, consider making a monetary contribution and becoming a silent partner. Depending on business success, you could begin to make money back in the future.
  • Invent something. If you are great at creating things and have a knack for finding out what sort of products people need, you might invent something. This could be anything from a program to a hair product. You never know how successful it could be and the money you might make over time.
  • Investment passive income. When you invest in something, you can make money from it. Especially if you pick a company or stock that does exceptionally well; do some research to find the best investment opportunities. 
  • Build a business. This one is only partially passive income. You begin your own business and make it bigger and more profitable until you need more people to help. Eventually, you can hire others to run it. Or you can sell it for a one-time amount.

Why is passive income better than active income?

When going over passive income vs. active income, you might wonder if one is better than the other. Usually, passive income is a much better long-term moneymaker. Why is this? 

Active income means that you must consistently work to make money. If you stop working, the income stops; not so with passive income.

You can earn passive income regardless of whether or not you are working that day. Once you set up everything, it won’t need as much attention by way of time or effort to continue making money. You can do the work and, to an extent, forget about it.

The reason many prefer passive income vs. active income is that passive income means short-term work and long-term gains. Typically, you can make more money than you spent to get the product or service started, and passive income is not dependent on how much time you spend on it.

Tax benefits

Depending on where you live and your current financial situation, earning money from passive income could have a lower tax rate than your actively earned income. Everyone’s situation will be different so it’s best to speak with your tax professional or CPA to find out.

Not trading time for money

Active income also requires constant creativity and energy to keep up with the demands of the job. Even if you enjoy what you do, you aren’t likely to want to do it forever.

So passive income has the advantage because it doesn’t need you to produce value or give your time consistently.

If trading your time for money was unnecessary and you’d get paid regardless of the time you devoted to a project, how would you spend your days? Would you think differently about life and potentially have more time for other creative pursuits?

This freedom is another way that passive income can help you.

Consistent income

While active income eventually goes away because people retire or quit working somewhere, passive income can continue for a long time without interruption. As long as the product or service is still popular, you can continue to build wealth.

With some time and focused effort, you can potentially set up enough passive income resources to receive money monthly or yearly that covers your expenses. When you have enough various passive incomes, you could find yourself not needing to work very hard for money anymore. 

Most people love the idea of having all of their monthly bills paid through passive income. It will allow you to work on other business ventures or spend your time on something else.

Thinking Ahead

If passive income is so important, how do you begin getting it set up today? For starters, find out what type of passive income sources are interesting to you. Pick one or maybe two to start with.

After you choose your sources, start setting them up. What you need to do will vary widely depending on what passive income path you take.

For example, you may need to create something to sell, set up a website, buy a rental property, or speak with your financial advisor to begin investing. 

Next, set a goal. How much passive income do you want to make? By what point do you want it to be profitable?

After you do this, simply continue with your path until you get to the outcome you want. This might be a short amount of time or several years. For example, a product might take only a few months to make money, where investing usually takes years. 

Eventually, your chosen resource will begin to afford you an income. It might be small at first, but hopefully, it has the potential to be a more considerable amount.

Don’t rely on one passive income source only. Once you’ve set one up and it’s going well (it doesn’t have to be making money yet), continue to build another resource, and so forth, until you have several.

A great thing for your finances is diversification. After all, what’s better than one income source? Two or three, of course. That way you can earn money in many ways. And it also helps with balance. If one source doesn’t make as much, another might make more, and so on. 

How To Know How Much Passive Income You Need?

When you’re just getting started and are still making active income, you probably won’t need much passive income. But if you’d like for it to replace your day job or help you make more money, you need to decide how much you want.

First, think about your expenses. How much per month do you need to cover those? Next, consider if you want to have any extra money each month. Deciding how much you want to make per month in passive income will help you know the yearly amount you need to make.

Keep yourself motivated by giving a number to your passive income goals. Then, keep that number in your mind every day, and even write it down, so you don’t forget. Having this type of reminder will help you stay motivated to increase your success with passive income vs. active income.

A frugal lifestyle to help with passive income 

Many people live off of passive income when they retire, and a lot of them retire well before their fifties or sixties!

Many times, if you want to afford a passive income lifestyle, it helps to be frugal. If you understand how to live on less then you won’t need as much money to support your lifestyle.

This can help you with your passive income goals. Here are some ideas for frugal living:

  • Skip the coffee. You can make your own coffee or breakfast at home before you go to work. This could save you $50 a week! Instead, place that money in savings for your passive income ideas.
  • Save on gas. Try to carpool when possible and use less gas for your car. You might save a whole tank’s worth of cash each month.
  • Free activities. Sure, you could go to the movies or a concert. But what if you instead tried out some inexpensive or free options? Things like taking a walk, visiting free museums, or exploring your city don’t cost anything and are still entertaining. 
  • Buy second-hand. You can purchase clothes and furniture for a small percentage of their original price if you buy second-hand. Many of these things are still in great condition, and you can save hundreds when looking for something you need for your home.

How to begin building passive income while still working

The chances are you still need to make money while you’re growing your other money resources. Otherwise, you wouldn’t be interested in passive income. So it’s important to keep doing well at your job in the meantime.

Devote your evenings, weekends, or any extra time you have to build your passive income sources. Remember, they take time at first, and then they’ll gradually need less attention. So start small, take your time, and sustainably grow your passive income.

Both kinds of income are important, but passive income is better

Making active income is the way that most of us start out. Many times, active income is what gives us the means to create passive income.

Most businesses or passive income sources can’t begin without at least a little bit of money. Because of this, active income has its purpose.

But you don’t want to rely on active income forever. It eventually becomes more difficult to earn a living in this way. So even if you rely on active income now, it should always be your goal to switch to passive income sources eventually. 

For at least part of your life, having a good mix of both active and passive income is very beneficial. It gives you the chance to build wealth in many ways with less risk. You can plan for the future while paying for expenses today. 

While you may want to skip directly to passive income, remember it does take time. You will get there if you just keep trying and building your resources slowly. In the passive income vs. active income debate, passive is the best choice you can make, so work towards it.

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Steffa Mantilla

Certified Financial Education Instructor

Steffa is a Certified Financial Education Instructor (CFEI) and the founder behind Money Tamer. Her 12-year background in operant conditioning and positive behavioral change training is used to help people find effective motivators to change their harmful money behaviors. Steffa explains the reasons “why” behind people’s financial behaviors and how to successfully change them. After paying off over $80,000 in debt through budgeting, she now teaches families how to get their own finances in order. You can learn more about her here.

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