We all need money to build wealth, pay for things we want, and reach financial goals. Just like there are basic financial terms you should learn, there are multiple types of income to master as well.
Different types of income each have advantages and disadvantages, so you should have a brief understanding of each. If you’re interested in increasing your income to pay off your student loans, here are 3 types of income to grow your wealth.
1. Earned income
Earned income is any income that you produce through an activity based on your time and effort. This may present itself in the form of a full-time job with a salary, owning a small business, or even freelance work.
A huge benefit to earned income is that you generally don’t need any startup capital. You can get started today by getting hired for a job, selling goods online, or performing services on the weekends.
It’s often a stable source of consistent income, making it a very popular choice among college grads and other career-minded individuals.
There are however, a few downsides to earned income. The main one? You are indeed exchanging some form of time or effort for money. And once you stop working, you’ll stop receiving any monetary benefit.
Compared to other types of income, earned income produced within the United States is taxed at the highest rate. It can be as much as 39% of your income, not including state income taxes.
Thus, earned income is the most expensive kind of income you can earn. For this reason, it’s important to learn how to diversify your revenue streams and not rely on earned income as the sole source of funds.
2. Investment income
Investment income, also known as portfolio income, is generated from the buying and selling of investments or assets. The more assets you own, the higher return on investment you’ll have to generate portfolio income.
There are many different vehicles for investing, from simple savings accounts that earn a small interest to stock market investing. Here are some examples of investment income:
- Stock market investing, like stocks or bonds
- Interest earned, dividends
- Buying and 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 to make a profit. Paper assets, such as those associated with the stock market, can be conservative or volatile forms of income.
You’re never going to have a lot certainty as to what the market will mean for your portfolio gains, therefore investment income is very unpredictable. You won’t have as much control over how much investment income you earn.
However, investments held over a year or more are considered long-term investments and are taxed at a much lower rate than earned income. Your investments could qualify for capital gains or qualified dividends tax rate versus the general income tax bracket.
You also have the benefit of earning compound interest (interest earned on interest) within your portfolio.
3. Passive income
Passive income is also known as unearned income because the money you make is created passively, or without much exchange of time and effort. Once the initial investment is made, whether that’s time or money you’ve put in upfront, the income venture continues to pay out with little to no future input.
For example, if you were to write a book and sell it to a publisher, you would continue to receive royalties on the sales of the book for many years without any additional work. Here are some popular types of passive income:
- Income from a rental property
- Royalty income from oil and gas minerals
- Pensions or settlements
- Creating and selling intellectual property
Passive income allows for the most favorable tax treatment. Similarly to investment income, you may be taxed at a lower qualified tax rate.
You can essentially reach retirement age and continue to earn money from previous passive income ventures, without having to worry about how to pay the bills. Many people consider passive income as the key to long-term wealth — and that’s something we should all ultimately strive for.
Your different types of income matter
Most college grads start their careers in the workforce expecting to earn an income for the rest of their lives, but this is not the only income stream you should strive to create. Learn to branch out and become your own boss, or invest in some real estate or intellectual property.
Don’t stunt potential income by limiting yourself to only one revenue stream. Make use of all 3 types of income and expand your revenue beyond just earned income. Doing so can help you pay off debt, build wealth, and reach financial freedom.
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