When it comes to your financial health, you must understand how you acquire money before you can be financially resilient and secure. One of the most basic concepts about money that you need to master is income.
Depending on your financial and occupational situation, you may be able to find additional income streams so you can earn more.
There are two types of income: active and passive income. While you can go on with your life without learning the difference between active income vs. passive income, knowing it can be insightful and may even lead to new opportunities.
What is active income?
Active income is defined as salary earned from specific duties or services rendered according to an agreed task, within a specified time frame.
Examples of active income are salaries, tips, fees, commissions, and allowances from the companies you provide services to. If you’re working for a person or a company–be it manual labor, office work, or home-based service–you earn active income. You can even be working for yourself, which is called being self-employed.
Active income earners are also either full-time, part-time, freelancing, or contractual workers. It is the most common type, if not the only type of income for most Filipino households.
Payment for active income earners happens every two weeks (colloquially called “kinsenas” or paid every 14 to 15 days). Some do get paid daily, weekly, once every month, or paid per project.
Another way a person can earn active income is by selling a product. Such is the case for artists, bakers, chefs, and tailors.
Having regular active income has distinct advantages. For one, it is more predictable and secure if you’re trying to budget your monthly expenses. It also comes at expected periods, so it is easier for you to save and plan.
However, a regular active income comes with challenges too. For one, it might not be enough to cover your living expenses. It could also be too meager for you to build an emergency fund.
Another challenge active income earners face is the reality that they cannot possibly provide certain duties or services their entire lives. It just is not humanly possible. So, what can you do about it? You may need to assess how to increase your income source.
See related: extra income tips from Metrobank
What is passive income?
Passive income is money from activities where you have no active or direct involvement. These may be investments you have made where you earn money or work you have done in the past that continues to pay dividends even in the present. In short, passive income describes the idea of “making money work for you.”
How do you earn passive income? Most of us are trained to attain only active income growing up, which is why only few know about passive income and how to earn it. Unlike being fully employed or doing freelance work, it does not require much of your time and effort. One common way is through opportunities and activities where you can turn money into assets.
Other ways of earning passive income are through buying and selling real estate, investing in “ownerships” of public companies through the stock market, investing in government bonds (which are IOUs by the government to those who want to grow their money for an agreed time), and setting aside money in time deposits, which can be used to help build an emergency fund. Passive income can also include royalties from a book you write, an online course you create, or the rent you receive from your real estate properties.
When you have passive income, you’re no longer solely dependent on your active income to cover for your living expenses.
Passive income sources let you profit whether you’re employed or not. Some passive income types can be lucrative, such as renting out properties you own where tenants are required to pay you monthly. Dividends from stocks can provide a steady stream of income since company payouts are scheduled quarterly or semi-annually. Interest earnings from government bonds, and time deposits are also passive income sources.
Keep in mind, however, that it takes years to build a sizable passive income. You need some sort of initial investment, be it in terms of finances or in terms of time, to start generating passive income. For things like rental properties, stocks and bonds, and even businesses, you need to shell out a lot of money upfront before they start generating passive income for you. Income streams like online courses, affiliate marketing, and blogging require a lot of time and effort to build up before you can earn from them. But once you have made the initial investments and your ventures go well, you rarely need to put in additional effort after that.
Many people are drawn to passive income streams and would love to have it as their main source of income however, the main benefit of passive income is also its biggest downside – the flexibility. With passive income, you have little control over your earnings. If you own a property that has no tenants, then you receive no money while having to pay real estate tax and association dues. Stock prices rise and fall, and thus you stand to lose money in stocks. Investing in corporate bonds also presents the risk of companies “closing down” and being unable to pay you back.
How to take advantage of both active income and passive income
Active and passive income are interconnected. The more you earn in terms of active income, the more you can invest to earn passive income. Besides this, you can invest more aggressively in passive sources of income if your active income more than covers your regular expenses. Of course, this assumes you have an emergency fund so that you don’t have to source money in the event of a sudden expense.
On the other hand, the more you earn from passive income, the more you can afford to take risks with your career, and possibly move to a more lucrative job.
Alternatively, the more you earn from your passive income, you might be able to take a job that pays less but is more aligned with what you want to do in life. In fact, one financial goal you can set is to earn so much from passive income that you can afford to work for fulfillment instead of money.
All that being said, an understanding of the differences and relationship between active and passive income can help you chart out your life in terms of finances. One might give way to the other. Having both active and passive sources of income open up possibilities and opportunities for you.