Types of Income PROPERLY Defined: Passive Income Redefined

This post may contain affiliate links. Please check out my disclosure for more information.

So, this is not an entirely new topic, but I must say that I have heard far too many people including personal finance pundits get this awfully wrong.

As you may be able to tell by the title, this article has a keen bias towards properly defining Passive Income.

Before we get there, let us define the main type of income that most of us can relate to, define two more income types, and then get into correcting this Passive Income fallacy.

Let us look into these Income Types. To me, there are only four types really.

Earned Income

The income most of us are familiar with on a personal level. By and large, this kind of income is derived from selling your time or skills, or a combination thereof, for money.

This kind of income should not be scoffed at, especially in the context of working towards financial freedom, because it can be highly lucrative, much more so in a case where you may possess or develop a High-Income Skill. Once you reach this level, people may be willing to pay a large premium to be able to benefit from your High-Income Skill.

This, for most of us, could be a low barrier-to-entry way by which to increase your income potential.

High-Income Skills

High-Income Skills Can Include:

• Public Speaking
• Presenting
• Sales
• Digital Marketing
• Copyrighting
• Photography
• Sports
• and much more

We all know people who do one of these and are either dirt poor, doing okay are absolutely killing it. Almost all who are hugely successful at one or more of these skills have incredible work ethic and drive. The only way to leverage this kind of skill to generate you ridiculous amounts of money is to fervently and relentlessly hone your craft.

The major disadvantage of this type of income is that you have to keep showing up or delivering your service to get paid. Also, although, for a lot of these, your skill could be transcribed to literature, audio or audiovisual, if the novelty of your skill has a contextual relevance that is not evergreen, then your ability to make money off it could be limited.

It is also very hard to create a succession plan for an income that is derived in this way. So you are unlikely to be able to pass this on to your loved ones. You can, and should, however, use the income that you derive in this manner to create a financially secure future for yourself and your family by making the right kind of investments.

Leveraged Income

This is income you can derive from social or political capital, or industry-related clout.

Paris Hilton and the Kardashians are probably the biggest examples of this. There is absolutely nothing wrong with this. I would do it as well if I could.

I would also categorize endorsements and sponsorships under this kind of income as they have more to do with who you are, than something you did or a product you created.

For instance, Nathan East (bass player for Fourplay and various other bands and artists) is endorsed by Yamaha. This endorsement is not because of an epic song he recorded sometime in the past, but more because of how a collection of his interactions with the music industry, more so the jazz community has lead him to become an icon with which Yamaha is willing to affiliate itself.

This doesn’t need to end here though, Nathan could just as easily have approached Yamaha and proposed a partnership with them, citing his influence in the music industry as a value proposition and bargaining tool.

Leveraged Income is Still Earned Income

Endorsements and sponsorships are NOT Passive Income though. I will not mention names, but these can come to an end at any time, as you may have probably come to notice by now.

Endorsements can be canceled; Sponsorships can be pulled. True passive income is not subject to these kinds of fallibility. Passive income continues whether you experience a fall from grace, get disabled or age. Moreover, you should not have to do anything or show up anywhere for money to flow.

We can all leverage social capital or influence to make money. The money needn’t be recurring, like endorsements or sponsorships. It could also be once off. It does not have to be a large sum of money either. We can all make this kind of income at some point in our lives through effective networking.

Leveraged income is NOT Passive Income. Also, leveraged income is still earned income, only, it is MUCH more volume-efficient; this is to say, you can make much more money from being a single entity, than you can with employment.

Residual Income

This, strictly speaking, is earned income, only, it generates money for you repetitively or after the fact.

Royalties, let’s say for a musician, let’s go with Marcus Miller this time, for a given song would generate income for him every time the song gets played. It would, however, only generate income for him for as long as people chose to imbibe his content. Say, for instance, he did something do offend his fans, and they decided to boycott his music. Just like that, bye-bye income.

The biggest advantage of Residual Income is that, unlike Earned Income, you only have to do the work once, generally speaking. This is very time efficient, much more so than selling your time for money. This makes increasing your income much easier because once you complete and release one project, you can start to work on the next, which upon its release, could potentially earn you money, side-by-side with your initial project, and the next, and the one after that.

Another advantage of residual income is that it can outlive you. We still listen to Michael Jackson, Prince and Amy Winehouse even though they have quite long ago passed away. And even though they aren’t here to enjoy it, we are paying to listen to their music and paying royalties to be able to do so.

Residual Income is Still Earned Income

While this holds true, the converse can as well. Residual Income can also be enjoyed for a very short time, and the creator of the content may outlive the monetary utility of their content.

Examples of careers that can generate Residual Income:

• Music
• Writing
• Blogging
• Vlogging
• Creating a Course
• Software/App Development

Again, here, people can stop imbibing your content or buying your product at any time and for any reason, thus it would be prudent to keep working, thus it is NOT Passive. Residual income is still earned income, only, it is MUCH more time-efficient.

It is also very hard to create a pure succession plan for this type of income, one that can continue to grow this income base after your departure. This It is not always truly transferable if you are the brand. You could, however, achieve this if you were to be able to successfully decouple yourself from the brand.

Passive Income

Real Passive Income does NOT require you to show up or do something. This would go against the definition of the word, “Passive”

I could only think of four true examples of Passive Income. Almost all of these afford you the opportunity to influence them, should you so choose. While this would render them arguably no longer passive, they afford you the opportunity to enhance them when you want to, and take a step back when you no longer want to actively participate in running them.

This is great, because you want the money they can generate you to be 100% passive, yet subject to your influence should you so choose.

My examples

• Owning a Property Portfolio
• Owning a Share Portfolio
• Owning a Business
• Creating a Business

Owning a Property Portfolio

Owning a Property Portfolio is first on the list because it’s the easiest and most conceivable for ALL of us to attain. Yes, even you. Indeed, even you. Also, property investment is loaded with tax advantages.

You DO NOT have to quit your job to achieve this.

In fact, your job as your biggest asset in this regard. Read, Your Mortgage is a Poverty Trap, to understand a little more about how this would work, and also read, Why You Need to Increase Your Credit Score Quickly, to understand how to leverage the ease of access to credit that your “stable”, “sturdy” and “reliable” paycheck can afford you.

Sourcing the same kind of financing may be a considerably more intense struggle for self-employed individuals, who the banks get a lot more nervous about funding.

Owning a Share Portfolio

This is second on the list because is also hard, but can be a lot easier for others depending on the size of your seed capital.

I have categorized this separately from owning a business, because it can be done with absolutely no involvement or knowledge of the granular details of how the business is run on a day-to-day basis.

Warren Buffet is probably the best example of this principle.

It must be said that, for this to really count, and by count, I mean, for you to actually be able to live off this kind of income, you have to either invest A LOT, make HUGELY successful investments that deliver high returns and wait a LONG TIME, or all three.

Owning a Business

This refers to successful businesspersons that are not necessarily entrepreneurs. That is to say, they do not create a system, but have a profound talent of being able to take businesses to the next level.

Fernando Duarte and Robert Brozin are good examples of this. This duo did not found what today is called Nando’s (originally called Chickenland). They did not invent the concept of selling grilled chicken and covering it in a signature sauce, yet without them Nando’s would not have become what it has today.

A similar story is true with Christoffel Wiese and Shoprite which was bought, followed by yet another acquisition of Senta (a distributor) and later another acquisition of OK Bazaars, all forming what he called the Shoprite Group, a massive retailer with a pan African presence.

Creating a Business

This one is the most relatable because we have examples of it all around us. It is also the hardest and involves the most risk and uncertainty.

Think:

• Steve Jobs,
• Elon Musk,
• Larry Page and Sergey Brin,
• Larry Ellison,
• Mark Zuckerberg.

You get the picture, but I don’t want this to start feeling too distant and unobtainable to you.

But these people all created from “nothing” businesses that are now much bigger than themselves and could potentially be given to other people to run.

Real Passive Income

I want you to notice two important characteristics of authentic Passive Income sources:

• All of these can be sold
• Nothing is Passive, Easy or Quick about getting to own them

Real Passive Income can easily have a succession plan. It can be sold, transferred or passed down. Read more about this here, Succession Planning and Your Business: Why Should You Care?

Also note that, much unlike the buzz phrase that has gained popularity on the internet, REAL Passive Income is NOT easy to come by. It takes a very long time to build, and building it is by no means easy.

That’s the truth about REAL Passive Income.

You Too Can Build Passive Income

This being said, it is possible for you to achieve any of these four.

Real Estate is just the easiest and most stable, so I would give that a bash before looking at the other stuff.

Read, Rent or Buy: Which is the Better Way to Build Your Wealth?, to get started on understanding how you can build your property portfolio.