Passive income and residual income are often mistaken for each other, or thought to refer to the same thing, but these are distinct financial concepts.
What is Passive Income?
Passive income refers to earnings that require little to no labor. Unlike income from a traditional source, like a job, where you have to work constantly for your earnings.
This kind of income usually requires a large initial investment, but then generates income over time. For instance, you could buy a property and then rent it out. You would generate monthly income from this rental property without having to work. This is a form of passive income.
You can create new sources of passive income in dozens of ways; investing in stocks or property, buying vending machines, renting out specialized equipment, making money with crypto, and so forth.
What is Residual Income?
Residual income is a much broader concept, and refers to the money left over after the “bills have been paid”, like debts and rent.
In personal finance, this is effectively your disposable or discretionary income. In corporate finance, it is more complex, and refers to a figure that takes into account not just the net income of a business, but also the cost of equity (i.e. dividend payments to shareholders).
Put simply, passive income is a type of income, whereas residual income is a calculation based on income minus expenditures.
You can increase your residual income by looking for a higher-paying job, boosting your earnings with a side hustle, or by reducing your monthly expenditures.
The key differences between passive income and residual income
Here is a basic overview of these two concepts, and how they differ:
|
Passive Income |
Residual Income | |
|---|---|---|
|
Definition |
Income generated without actively having to work for it. |
What remains of your income after covering all financial obligations and regular expenses. |
|
Effort Required |
Little to no effort required after initial setup. |
Requires regular effort to generate base income. |
|
Purpose |
Generates wealth over time, and once established, can replace regular work all together. |
In personal finance, residual income allows you to invest, save or spend. In corporate finance, residual income can effectively be used to calculate the profitability of a business. |
|
Examples |
Rental income from a property, dividends on stock, ad revenue from a blog or YouTube channel. |
The income an individual has at the end of the month after paying rent, debts, and all regular bills. |
|
Risk Level |
Typically very low, but can vary (i.e. property is safer than investing in a startup). |
Tied to how secure the source of the base income is. |
|
Tax Implications |
Almost always taxed differently from regular income. Requires additional bookkeeping. |
Usually no additional implications. |
As you can see, residual income is clearly an important concept for everyone to understand, whereas passive income may only seem relevant to those with enough capital to create a passive revenue stream.
But if you boost your current earnings with casual work, like making money from home by completing tasks on get-paid-to platforms, you can probably begin building passive income sources sooner than you think.
