What is Passive Income? 

Passive income is income that is earned without ongoing involvement after an initial investment of time, money, or resources. Some examples of passive income include rental property income, dividend income from investments, interest income, and business income. A person is not actively involved in day-to-day operations but was involved in the initial investment and creation.

What is Residual Income? 

Residual income is earned from work and activities completed upfront but is no longer actively worked on. Some examples of residual income include royalties from books, music, or movies, real estate investing through rental income, stocks, and bonds. 

It is important to note that residual income is the money remaining after other expenses have been met. If income does not surpass costs, it is not considered residual income.

Pros and Cons of Passive and Residual Income 

Pros

• Passive and residual income create a sustainable and recurring revenue stream that helps individuals meet financial goals and reach greater financial security.

• After the initial time or monetary investment, there is very little time commitment to continue revenue flow.

• This additional income allows individuals to diversify their income, which reduces reliance on a single income and provides for future scalable growth.

Cons 

• An initial investment of time, money, and resources is a barrier for those without disposable income and available time.

• Income streams are out of an individual's control because changes in the market and industry impact their performance.

• They pose a potential risk of investment loss if they don't go well due to market fluctuations and industry trends.

• Income revenue streams take time to establish, which is difficult for those with immediate income needs.

Passive and Residual Income: A Comprehensive Comparison 

Because residual and passive income are similar, it is easy to confuse them. Though they have many of the same elements, there are differences throughout their origin, all the way to their return on investment and how they impact a portfolio. Below we cover each aspect and discuss the differences.

Origin of Income

• Both forms of income require some initial investment that differs based on the type of income you seek and the type of investment. Residual income is considered passive income in some cases, but passive income isn’t always residual. Passive income is earned with little ongoing investment after the initial time and money –for example, income from investment dividends or rental payments. Residual income includes all money left over after expenses are accounted for from the initial process. It takes an investment to publish music and books and funding to purchase rental properties, stocks, and bonds.  

Intended Function

• The intended function of both forms of income is to supply a steady state of income aside from a day-to-day job. Passive income offers a steady revenue stream with very little ongoing maintenance, which frees investors up for more money-making opportunities. Residual income, on the other hand, is necessary to apply for additional loans to further income opportunities. You may receive passive income, but it only becomes residual once your income exceeds your investment. 

Level of Involvement

• The level of involvement for both forms of income is up to the individual. However, ideally, involvement is minimal after the initial investment process. Passive income will have minimal involvement once the initial process is complete and income begins. Residual income will have minimal involvement once expenses are accounted for and income exceeds the investment.  

Longevity and Sustainability

• Depending on the method, the longevity of an investment is difficult to predict. Passive income often relies on trends such as crafting or drop-shipping that are initially profitable but are short-lived and unsustainable. Though rental properties, stocks, and bonds have more stability in the long run. Residual income must factor in perpetual growth and sustain other income streams. Investing in bonds, rental properties and stocks is more expensive, though they are more long-term, stable and lead to residual income.

Impact on Financial Stability 

• Both forms of income will increase financial stability. Passive income is excellent for extra income. However, it is essential not to overinvest before the return exceeds the investment. Residual income is crucial for stability because it means your costs are covered, and additional money can be used to reinvest or lead a more comfortable life. 

Tax Implications 

• Both types of income are taxable, but their rates will vary. Passive income is taxable but generally at different rates than active income.  Residual income considers how much money you bring in versus how much money has gone into the investment. It’s best to consult a financial advisor or tax accountant to ensure you get the best tax rate. 

Passive and Residual Income Portfolio Diversification

• Multiple income streams are used to diversify a portfolio and decrease the volatility of investments by spreading them across different places. Passive income helps bring in additional revenue and increase financial stability, but only when the initial investment is worth the gain. Residual income funds new assets, helps grow current investments, and increases stability when income continually exceeds investment costs. 

ROI (Return on Investment)

• ROI varies greatly depending on the investment. Generally, the larger the investment, the greater return. Some forms of passive income, such as purchasing a laundromat, have slow but steady returns that are great for long-term income but may not generate enough income to live off of. While some forms of residual income, like selling an asset, have immediate returns but poor sustainability. It is essential to weigh the pros and cons of different investment opportunities to meet your lifestyle needs. 

Available Opportunities 

• Theoretically, anyone can set up additional revenue streams, but an individual’s financial ability limits the size of the investment. There are many opportunities, such as social media partnerships or affiliate marketing schemes. However, they require a significant time investment before income goes from passive to residual. Look into property purchases, bonds, or stocks for opportunities that require less time and have a higher ROI. Though they require a more significant monetary investment up front, they increase the likelihood of increased income opportunities once residual income increases. 

Potential Risks

• There is always a risk with any investment when establishing additional income. For passive income, ensure that the investment is affordable, and once setup is complete, the individual doesn’t have to be readily involved. For residual income, adequate research is necessary to ensure ROI will allow for additional loan investments and income.

Learn how to utilize passive and residual income to increase your financial security! 

Though passive and residual income are often used interchangeably, they are different. Passive income is money continually earned after the initial investment, while residual income consists of the money left over after costs are met. Both income sources help grow assets, generate profit, diversify portfolios, and increase financial stability. As long as the initial investment is affordable, adding a source of income is a great move. 

Talk with a financial advisor if you are still deciding what steps to take to start the process. A financial advisor will assist with creating investment goals that meet your needs and plans. 

Schedule a one-on-one coaching session with Invested Mum to learn more about investing today and set yourself up for a financially successful future!