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How do you know if you’re looking for passive income vs residual income? And what’s the difference between the two?
If you look into different ways to earn passive income for any amount of time, you’ll probably notice that people will also often refer to it as “residual income”.
Though the two are very closely related in definition, there is a difference. We’ll show you what the difference is between passive income vs residual income.
In addition, we’ll show you how to find the secret to which one is best 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.
Passive Income Definition
The actual definition of what is passive income comes straight from the IRS:
Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity
Translation: Basically it’s any income that is earned passively or without much involvement from the recipient of the income. Wikipedia offers several examples:
- Rental property that’s managed by someone other than you
- Dividends from stocks, mutual funds, etc
- Interest on savings and other accounts
- Earnings from owning a business partnership in which you’re a passive partner
The trend to notice is that in all cases, the passive income involves some kind of initial monetary investment as a way to start the process of making more money.
For example:
- You had to buy the property to rent it out
- You had to buy the stock shares to receive the dividend payments
- You had to invest money into a CD to receive interest
- You had to invest in a stake of the company to make a partnership and receive a cut of the earnings
What is Residual Income?
While passive income takes some initial monetary investment, residual income differs by receiving income after you do some initial work.
For example:
- Royalties you receive from an e-book you created
- Money you get from recruiting successful team members in a multi-level marketing company like Mary Kay or Pampered Chef
- Creating blog posts or articles to sell something over the Internet that doesn’t belong to you such as with an affiliate program
- Royalties from a song you recorded
One could argue that “time” was certainly invested in each one of these activities, so that’s where the difference between the two can become somewhat of a grey area.
Needless to say, most of the time you would be fine using the two terms interchangeably since their definitions are so closely related.
Other Definitions for Residual Income
It is important to note that there are other existing definitions for residual income. For example, if you look up residual income in Google, one of the first definitions you will find is from Investopedia:
The amount of income that an individual has after all personal debts, including the mortgage, have been paid. This calculation is usually made on a monthly basis, after the monthly bills and debts are paid.
Also, when a mortgage has been paid off in its entirety, the income that individual had been putting toward the mortgage becomes residual income.
In other words, this definition describes residual income as any extra money you have left over after you pay your bills or pay off a debt.
As you can tell this definition, although accurate, is off topic and out of context from what we are talking about today.
Residual Income as Additional Income
Some people define residual income in a third way: as income that differs from your main 9-to-5 job. This is primarily the way we define residual income on this site.
Some examples of residual income via this definition could include:
- freelancing your skills, such as writing or web design
- working a second job
- having a side hustle business such as mowing lawns or babysitting
- Using your talents to sell stuff such as products, crafts, etc.
This type of residual income often pays more for the work you do than your 9-to-5 job does. You’re cutting out the middleman (the company you work for) so you’re getting profits directly.
You have more control over the hours you work and the income you make as well.
Should You Choose Passive Income or Residual Income?
So the question becomes “Which should you choose?” In all honesty, my opinion is that any time you can get more money for doing less work you should jump on that fantastic opportunity.
Simply put, you should pursue BOTH passive income and residual income if you can. Of course, using your residual income to create more passive income avenues is the ultimate goal.
The more income you make, the faster you’ll reach your financial goals – IF you manage that income properly.
And the more passive income you have, the more freedom you have with your time. However, the types of passive vs residual income you choose should depend on a few factors.
Your Skill Sets
Your skill sets – or the skills you’re willing to learn – should make a difference in the income sources you choose.
For instance, if you have the skills to write a phenomenal e-book or life changing video course, go for it!
How about learning a new skill? When I started blogging, I knew nothing about any bit of the process. I’d barely even read a blog post!
Luckily, companies like Bluehost make it super easy for newbies to learn how to create and manage a blog. In fact, you can start a blog in under 10 minutes with our How to Start a Blog and Make Money guide.
Use your skills and talents – or be willing to learn new ones – to create passive or residual income sources.
The Amount of Money You Have Available
The amount of money you have available makes a difference in which types of passive or residual income you can choose.
As an example, if you’ve got several thousand dollars you could invest in blue chip stocks, so get at it!
Maybe you’ve got money set aside to purchase a rental property. If you don’t, why not invest in a crowdfunded real estate company such as Fundrise.
With Fundrise, you can start investing in real estate for as little as $500. There are other real estate investment options that don’t involve direct ownership too.
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’re comfortable taking. There are several online risk tolerance quizzes you can use to determine your risk tolerance level.
This easy quiz from the University of Missouri is a good place to start. Some paths to passive or residual income require more risk than others.
For that reason, it’s important to know your risk tolerance level before choose a passive or residual income source. That way you’ll be sure to choose a residual income source that lines up with the level of risk you’re comfortable with.
As an 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 Streams of Income
I’ve mentioned before on this site that I’m a huge fan of people having multiple streams of income. Here’s why.
Whether you’re working or investing, having all of your eggs in one basket always increases your risk level.
As an example, let’s say your one source of income is your 9-to-5 job. If you get laid off tomorrow, you’re now without any income sources.
However, let’s say you have several sources of income, such as:
- Your 9-to-5 job
- A side hustle mowing lawns for neighbors
- Your pet sitting business
- A blog that brings in a few hundred dollars a month
- An investment account that pays you dividends of a couple hundred dollars a month
If you get laid off from that 9-to-5 job tomorrow, it’s not as big of a deal. Why? Because you’ve got four other sources of income that can help you pay the bills until you find another job.
Hopefully, you’ve got an emergency fund too that will help carry you over in times of money shortages. If not, get to building your emergency fund quickly as an extra measure of security.
So work on making multiple streams of income a part of your quest for financial security. When rough financial waters hit, you’ll be glad you did.
Summary
There is a bit of a difference in passive vs residual income. However, at the end of the day the important thing to know is that the both make you money.
The money made through passive and residual income sources is typically different than money you’d 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 sources that line up with your skills, interests and tolerance for risk.
As you build up your different sources of income, you put yourself in a better place financially, provided you choose the right income sources for you.
Choose today to start finding the right passive income sources for you. Which passive or residual income sources are you most attracted to?
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