Investopedia defines income as “money an individual or business receives in exchange for providing a good or service, or through investing capital.” Income make up cash inflows. Income is used to fund day-to-day expenditure, long-term projects, vacations and other needs. To be financially literate, it’s important to know the types of income and how to use them.
Experts say there are three types of income
- Earned Income
- Portfolio Income
- Passive Income
Earned Income- Also known as active income, is the income received from activities which one exerts one’s time and efforts. Examples of activities that generate this income are paid employment, small business, consultancy. This income is the easiest to get but the disadvantage is that when you stop working on these activities, the income stops coming in. However, one great advantage of this class of income is that you can use this income to build income in the other classes (portfolio income and passive income)
Portfolio Income- This is the income generated from selling an investment at an higher price that you bought it. Examples include trading paper assets like bonds, stock, treasury bills or other forms of securities, buying and selling real estate, cars and other types of assets. Characteristics of portfolio income include it involves huge capital and also involves good knowledge and expertise.
Passive Income- This is the type of income you earn even while you sleep. Passive income is the recurring income you generate from activities you are not actively involved in. This is widely known as the key to building wealth. Examples include rental income from real estate, dividend income from equities/stock, creating and selling intellectual property, owning a business that can operate independently without your direct supervision.
Settling with earned income is not enough, you work for money alone without letting the money work for you. It’s important you make money work for you by generating passive income. This is the point of financial freedom when your passive income can cater for your expenses.
Finally, understanding how income works is important because it influences the choices you make with money.
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