Passive Income vs Active Income: What an Investor Should Know

Why You Need Passive Income

Regardless of the source from which your income is derived, it will fall into one of two types — passive and active. The money you earn in the form of a salary, wages, commissions or tips is considered active income. The more elusive passive income is money generated from investments such as stocks, bonds, real estate holdings or any other income-producing asset. There are other differences between the two as well, so let’s take a look at passive income vs active income to discover some of the key things an investor should know. 

What is Income?

One of those words you’ve used all of your adult life, but probably never stopped to define clearly, income is money received in exchange for performing a service, investing capital or working a job. Thus, income can be comprised of wages, salaries, profit, interest payments, and rent. 

However, income is also a term used to identify an accumulation of the means of consumption, whether in the form of money or a tangible benefit in lieu of money.

Examples of non-monetary income include perks offered by employers such as gym memberships, flextime and medical benefits. 

Ultimately though, economics defines income as any consumption or saving opportunity you take within a finite period of time — typically annually.

What is Active Income?

As mentioned above, active income is earnings derived from an  effort of some sort. The most common form of active income is the money you’re guaranteed to receive annually in exchange for sharing your time and skills with an employer — your salary. 

Along these same lines is the hourly wage, which, unlike a salary, is only guaranteed for the number of hours you and your employer agree upon. However, wage earners can increase their incomes by working additional hours, which is also known as overtime.  

One of the most lucrative forms of active income is commissions. These are paid in the form of a percentage of the price for which you sell a good or service. For example, real estate agents earn a percentage (usually 3%) of the sale price of a home when they find a buyer for it. If you sell a home for $1,000,000 at a 3% commission, you’ll earn $30,000. 

Independent professionals, consultants and freelancers are paid fees in exchange for completing a specific task or set of tasks. Lawyers, writers, photographers, business advisors and the like earn their incomes in the form of fees. 

While its potential is virtually unlimited, an active income does have shortcomings. One is you can only generate an active income for as long as you are physically able to perform the task or provide the service for which you are paid. The other downside is that active income typically comes with a rather significant tax liability. The average tax rate on wage earners was 13.3% in 2022.

What is Passive Income?

Funds derived from the value of an income-producing asset are referred to as passive income. Granted, that asset may have been acquired using funds gained from an active income-producing endeavor, however when those dollars are invested into an asset, the resulting income is considered passive. 

Examples include the interest earned on a savings account, bond, or a certificate of deposit. Dividends generated by stocks fall into this category as well. Cash investments in fledgling companies, serving as a silent partner in an ongoing business enterprise and real estate holdings are also capable of generating passive income. 

When it comes to passive income vs active income, the former keeps accruing as long as the asset from which it is derived remains a sound investment. It often comes with tax breaks too.

Passive Income Taxation

The IRS considers income derived from businesses in which you are not an active participant to be passive. Said income is taxed, but in a fashion that is different from active income and usually at a lower rate. 

Selling an asset can also trigger passive income tax liabilities. These vary according to the value of the asset, the type of asset and the amount of time you held it. However, these tax liabilities can often be mitigated by reinvesting the proceeds of the sale, among other strategies.

This subject can get quite complicated, so it’s always a good idea to consult a tax professional before investing in an asset likely to produce passive income to determine what your tax liability will be and how to protect yourself from excessive taxation.

Generating Passive Income

While it might seem a bit abstract at first glance, generating passive income is easier than it looks. In fact, there are a number of simple ways to make money without physically working for it.  

Purchasing a rental property is a tried and true method of setting yourself up to benefit from passive income generation. What’s more, doing so can be more affordable than you might think. Let’s say you own a home near a heavily used transit station, or in an area where monthly parking fees are high. Renting your driveway will generate passive income. So too will taking in a roommate or a boarder. 

Investing for your retirement is an oft-overlooked form of generating passive income, probably because you’ll only see the return after you stop working. However, that’s when you’re going to need  a source of passive income the most. Contributing to to your 410(k) plan at work and investing the money will generate passive income — and even more so when your employer offers matching funds and you start investing at a young age. 

Diversification of Income Streams

Diversifications is another aspect to consider when comparing passive and active income. Diversifying your income streams can create a more stable financial situation. Relying on active income leaves you vulnerable to potential job loss or changes in the economy in general. At the same time, relying only on passive income can expose you to fluctuations in interest rates, dividends, and real estate markets. By incorporating both active and passive income streams, you can reduce your risk and increase financial resilience in times of economic uncertainty.

Time and Effort Commitment

Time and effort is another distinction between passive and active income. Active income typically requires ongoing dedication and involvement. This may be appealing for those who thrive on personal engagement and enjoy the hustle of an active profession. Passive income, in its turn, often requires a smaller time commitment once the initial investment is made. This allows individuals to focus on other pursuits, such as personal development, hobbies, or even extra income streams. Nonetheless, it is important to remember that even passive income sources still need oversight and management to maintain their viability.

Yieldstreet and Passive Income Generation

Yieldstreet is an alternative investment platform connecting mainstream investors with passive income-producing opportunities typically available only to institutions and the super-wealthy.

One of the best things about investing with Yieldstreet is the ability it affords to access a broad range of asset classes that typically operate independently of the stock market. Even better, you can get started with as little as $10000 and grow your portfolio by reinvesting your earnings. Many of Yieldstreet’s investment opportunities are backed by collateral, which has the potential to afford you a degree of security for your capital. 

Asset classes available on the Yieldstreet platform include art finance, real estate, commercial finance and legal finance. These have long been considered to generate solid returns and have historically been closed off to retail investors. Yieldstreet’s mission is to democratize passive income opportunities offering yield targets ranging from 7-15% and predefined payment schedules.

When it comes to passive income vs active income, there are a number of advantages to be gained from the former. Chief among them is that passive income may continue long after you are rendered incapable of generating an active income. 

Here’s how you can start generating passive income today with Yieldstreet.