Summary

Understanding the three primary types of income—earned, portfolio, and passive—is crucial for wealth accumulation, with passive income offering the most control and tax benefits.

Abstract

The article emphasizes the importance of diversifying one's income streams beyond traditional earned income, which is the most heavily taxed and least controllable. It outlines the three main types of income: ordinary earned income, portfolio income, and passive income. Earned income is the typical paycheck from a 9-to-5 job, which is subject to various tax deductions and can be unpredictable due to factors like job market fluctuations. Portfolio income, such as returns from stocks and bonds, is moderately taxed and offers lower returns, with wealth accumulation dependent on market performance and the investor's ability to save from their earned income. Passive income, derived from royalties, real estate, and business distributions, is highlighted as the most advantageous for building wealth due to its lower taxation, ongoing cash flow, and the control it provides to the earner. The article suggests that converting earned income into passive income is a key strategy for wealth building, advocating for the reinvestment of financial gains into assets that generate passive income rather than immediate consumption or low-yield savings.

Opinions

Earned income, while the most common, is seen as the least effective for building wealth due to high taxes and lack of control over job security.
Portfolio income is viewed as a moderate path to wealth, but it comes with significant market risks and lower returns compared to potential passive income streams.
Passive income is portrayed as the ideal form of income for wealth accumulation, offering the most control, the lowest tax rates, and the potential for continuous cash flow.
The author suggests that individuals should prioritize investing in passive income streams over spending increases following salary raises.
There is a critical opinion of traditional employment and reliance on a single source of income, with a strong recommendation to pursue multiple streams of income, particularly passive income, for financial stability and growth.
The article implies that financial advisors and market performance play significant roles in the success of portfolio income, which can be a source of uncertainty for investors.

Know What Kind of Income You Are Working For

And find out which is best for you.

Photo by **Alexander Mils** from **Pexels**

Most people grow up thinking that earning a paycheck is the only way to earn a living. Earned income is how most people earn a living. Trading their time and skills for a payday but there are two other primary types of income. If you want to accumulate wealth, you need to know all three.

The three types of income

There are three primary types of income.

Ordinary earned income
Portfolio income
Passive income

Many subcategories fall under each main category but regardless of the type of income someone can collect, it will fall under one of the three named above.

Ordinary earned income

This is how most people earn their income. They go to work for long hours doing the 9 to 5 and collect their paycheck every week, two weeks or the end of the month. This type of income is the highest type of taxed income and therefore makes it hardest to build wealth.

Every working Joe reading this has looked at his pay statement and seen the long list of tax deductions and then compared the two numbers, starting pay before taxes and then at the end after all the taxes and deductions are taken out, what ends up in his pocket. I can not think of anybody who was happy after seeing the difference between the numbers.

With earned income your earnings are determined upon how long you can work. You also have the least amount of control over your earnings. Business is bad? You may have to take a pay cut to keep your job or you just might be let go. Getting too old and expensive? Your boss just might hire that younger person that costs only half as much. Through no fault of your own, you could be enjoying a well-paying job one day and the next day you can find yourself in the unemployment line.

Portfolio income

Most higher paid employees have some sort of portfolio income. This may be a 401(k), an IRA or various paper assets like stocks, mutual funds managed by a financial advisor or bonds. Portfolio income is generally derived from these paper assets and either reinvested into the fund or paid out in dividends. It is the second-highest taxed income of the three income types. It is moderately difficult to build wealth due to lower returns.

If you google “Average stock market return” you will see many experts saying you can expect an average of a 7% return over the long term. What is long term? About 30 years. Of course, you need to earn enough earned income so that you have the extra money to invest.

Very much like earned income, you have very little control over your portfolio income. The ups and downs of the stock market and the expertise of your financial advisor play a large factor in how much you earn.

You could quit your job and become a day trader. This is an option but you better be prepared to learn a lot quickly. Many a person has tried to time the stock market and ended up losing their house.

Passive income

Passive income is derived from royalties, real estate and business distributions.

Most people know about royalties from books or music. You put in the work once and the work keeps paying out as long a people are buying your books or music. Somewhat like a normal job, you put in your blood, sweat and tears into your work but the work keeps paying you after it is finished. There may be secondary work like promotion of your work or going back and doing revisions but this is the type of income you earn while you sleep. Once the distribution system is set up, book and record sales can happen over the internet while you sleep, eat out with your loved ones or are taking a vacation in the Bahamas.

If you receive rent from a property, it is passive income. Again, it works on the principle of putting the work in, finding the property, securing funds to purchase the property, finding renters and setting up systems to maintain the property and collect the rent. Once those are in place you just let the system pay you while you continue to build your empire or do what you want.

Business distributions get into an area that I will not go into great depth since I am not a financial advisor and there are a lot of tax laws involved.

The great thing about passive income is you have the most control of the situation and it is the lowest taxed type of income as well as providing many tax benefits. If you want to build wealth, this is the area in which you need to concentrate.

The path to building wealth

The path to building wealth lies in understanding the income and converting your earned income into passive income. The next time you get a raise, instead of splurging for that new toy, start turning it into passive income. The money you earn from your passive income can buy the new toys.

Pay yourself first. Not necessarily by saving, because low returns and inflation will eat that up, start investing in a passive income that increases your cash flow. Cash flow can open up new avenues you never had before.

Originally published at https://pivottowardsfreedom.com.