Money makes the world go ‘round and we all need it in some form or fashion to survive. Just like there are basic financial statistics you should know, there are also different types of income. If you want to make the most of your finances, it’s important to know there are more ways to be wealthy than by working for a wage. Here’s a brief guide to understanding three different types of income, and why it’s important to consider all three.
1. Earned Income
Earned income is any income you work for. That may be from a full-time job with a salary, owning a small business, or freelancing. A huge benefit to earned income is that you generally don’t need any startup capital. It’s often a stable source of consistent income, making it a very popular choice among career-minded individuals, families, and those looking to save for the future.
Types of earned income include:
- A full or part-time job
- Owning a small business
- Freelance or self-employed work
- Other income you work for
There are however, a few downsides to earning your income. Primarily that once you stop working, money also stops coming in. In the United States, earned income is taxed at a higher rate than other types of income, making it the most expensive kind of income we can earn. This is one of the main reasons we are encouraged to diversify our income streams.
2. Investment Income
Investment income, also called portfolio income, is generated from buying and selling investments or assets. There are many different vehicles for investing, from simple savings accounts that earn a small interest rate, to stock market investing and acquiring real estate.
Types of investment income include:
- Stock market investing, like stocks or bonds
- Buying/selling real estate
- Purchasing other assets like art, antiques and collectibles
Investment income carries some amount of risk and requires a good bit of knowledge. You can choose a portfolio that’s more conservative or one that’s more volatile. Either way it’s a bit of a gamble and you won’t have as much control over your money. However, investments held long-term are often taxed at a much lower rate.
3. Passive Income
Passive income, or unearned income, is money you make passively or without much effort and time spent. Once the initial investment is made (whether it be time or money) the income continues to be produced with no other output.
Types of passive income include:
- Rental or royalty income
- Unearned business income
- Pensions or settlements
- Other income produced after an initial investment
Passive income allows for the most favorable tax treatment and is considered the holy grail of all types of income. Many people consider passive income as the key to long-term wealth and it’s something we should all ultimately strive for.
The importance of knowing your options
Most of us start off in the workforce expecting to earn an income our entire lives. Some of us might branch out and become our own bosses, but we shouldn’t limit our potential. There are many other options out there for earning an income. Some of them are riskier than others, but if you know what you’re doing, the risk might be worth the reward.
Carrie Smith is a PerkStreet Customer Columnist who has worked as a freelance Certified Bookkeeper for nine years and as a Tax Specialist for four. She specializes in small business and oil and gas accounting. She has written several finance and accounting articles at Hubpages.com, and also writes regularly on her own blog CarefulCents. Follow her on Twitter @applecsmith.