How do you know if you’re looking for passive income versus residual income? What is the difference between the two?
If you’ve researched different ways to earn passive income for any period of time, you’ll likely notice that people often also refer to it as “residual income.”
Although the two are closely related in definition, there is a difference. We’ll show you the difference between passive income and residual income.
Plus, we’ll show you how to find the secret that works for you.
What is Passive Income vs. Residual Income?
Many sources define passive income and residual income as the same thing. The two terms are closely related but there is a difference. Before we look at residual income, let’s first review the definition of passive income.
Definition of passive income
Here comes the actual definition of what passive income is Directly from the IRS:
Passive activity income includes all income generated by passive activities and generally includes gains from the disposition of an interest in a passive activity or property used in a passive activity
Translation: Basically it is any income earned passively or without significant involvement from the income recipient. Wikipedia provides several examples:
- Renting properties managed by someone other than you
- Dividends, mutual funds, etc
- Interest on savings and other accounts
- Profits resulting from owning a business partnership in which you are a passive partner
A trend to note is that in all cases, passive income involves some sort of initial cash investment as a way to start the process of earning more money.
For example:
- You had to buy the property to rent it out
- You had to buy shares of stock to receive dividend payments
- You had to invest the money in a CD to receive interest
- You had to invest in a share of the company to establish a partnership and get a portion of the profits
What is residual income?
While passive income requires some initial cash investment, residual income differs by receiving income after making some initial investments a job.
For example:
- The royalties you receive from an eBook you create
- The money you get from hiring successful team members at a multi-level marketing company like Mary Kay or Pampered Chef
- Creating blog posts or articles to sell something online that is not yours, as with an affiliate program
- Royalties from the song you recorded
One could argue that “time” has certainly been invested in each of these activities, so the difference between the two can become a somewhat gray area.
It goes without saying that most of the time it would be fine to use the two terms interchangeably because their definitions are closely related.
Other definitions of residual income
It is important to note that other definitions exist for residual income. For example, if you search for residual income on Google, One of the first definitions you’ll find is from Investopedia:
It is the amount of income an individual receives after paying off all personal debts, including a mortgage. This calculation is usually done on a monthly basis, after paying monthly bills and debts.
Also, when the mortgage is paid in full, the income that the individual was putting toward the mortgage becomes residual income.
In other words, this definition describes residual income as any extra money you have left over after paying your bills or paying off a debt.
You can also say that this definition, although accurate, is off topic and out of context of what we are talking about today.
Residual income as additional income
Some people define residual income in a third way: as income other than your main 9-to-5 job. This is primarily how we determine residual income on this site.
Some examples of residual income by this definition could include:
- Freelance work on your skills, such as writing or web design
- Working a second job
- Having a side job like mowing lawns or babysitting
- Use your talents to sell things like products, crafts, etc.
This type of residual income often pays more for the work you do than your 9-to-5 job. You’re cutting out the middleman (the company you work for) so you get to see the profits directly.
You have more control over your working hours and the income you earn as well.
Should you choose passive income or residual income?
So the question becomes “which one should you choose?” In all honesty, my opinion is that any time you can get more money for doing less, you should take this great opportunity.
Simply put, you should pursue both passive and residual income if you can. Of course, using your remaining income to create more passive income avenues is the ultimate goal.
The more income you have, the faster you will reach your financial goals – if you manage that income correctly.
The more passive income you have, the more freedom you have to use your time. However, the types of passive versus residual income you choose should depend on several factors.
Your skill sets
Your skill sets – or the skills you want to learn – should make a difference in the income streams you choose.
For example, if you have the skills to write an amazing eBook or life-changing video course, go for it!
How about learning a new skill? When I started blogging, I knew nothing about any part of the process. I’ve barely read a blog post!
Fortunately, companies love Bluehost Make it super easy for beginners to learn how to create and manage a blog. In fact, you can start a blog in less than 10 minutes with our How to Create a Blog and Make Money guide.
Use your skills and talents – or be willing to learn new ones – to create passive or residual income streams.
The amount of money you have available
The amount of money you have available makes a difference in the types of passive or residual income you can choose.
For example, if you have several thousand dollars, you could invest in blue chip stocks, so go for it!
Maybe you have money set aside to buy a rental property. If you don’t, why not invest in a crowdfunded real estate company like Fundrise.
with FundraisingYou can start investing in real estate with an amount starting from $500. There are other real estate investment options that don’t involve direct ownership as well.
Your risk tolerance level
When it comes to investing, knowing your risk tolerance level is important.
Your “risk tolerance level” is defined as the amount of risk you can comfortably take. There are many online risk tolerance tests that you can use to determine your risk tolerance level.
This easy test University of Missouri A good place to start. Some passive or residual income paths require more risk than others.
For this reason, it’s important to know your risk tolerance level before choosing a passive or residual income source. This way you will be sure to choose a source of residual income that is in line with your level of risk.
For example, if you have a low risk tolerance, you probably don’t want to sink tens of thousands of dollars into a high-risk mutual fund.
Multiple sources of income
I’ve mentioned before on this site that I’m a huge fan of people who have multiple sources of income. This is why.
Whether you are working or investing, having all your eggs in one basket always increases your risk level.
For example, let’s say your only source of income is your 9-to-5 job. If you were laid off from your job tomorrow, you would now be without any sources of income.
However, let’s assume you have several sources of income, such as:
- Your 9 to 5 job
- Side hustle of mowing the neighbors’ lawn
- Your job is pet sitting
- A blog brings in a few hundred dollars a month
- An investment account that pays you a few hundred dollars in dividends per month
If you got laid off from your 9-to-5 job tomorrow, it wouldn’t be that big of a deal. Why? Because you have four other sources of income that can help you pay the bills until you find another job.
Hopefully, you also have an emergency fund that will help you in times of money shortages. If not, build up your emergency fund quickly as an added safety measure.
So make multiple sources of income part of your quest for financial security. When tough finances hit, you’ll be glad you did.
summary
There is a slight difference in passive income versus residual income. However, ultimately the important thing to know is that they both make you money.
Money earned through passive and residual income sources is usually different from money you make at a regular day job that pays you an hourly wage. In fact, the potential for earnings growth can be astronomical.
Your goal is to find the types of residual and passive income streams that match your skills, interests, and risk tolerance.
When you build your various sources of income, you put yourself in a better position financially, provided you choose the income sources that are right for you.
Choose today to start finding the right passive income streams for you. What passive or residual income streams are you most attracted to?