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passive income vs residual income

Passive income and residual income are two types of personal revenue that separately or together can have a sizable effect on an individual’s financial comfort and ability to reach financial goals. Passive income is money earned without significant ongoing active effort while residual income refers to the funds an individual has left after living expenses have been covered. Generating passive income can increase the amount of an individual’s residual income. Reducing living expenses or finding ways to create additional earned income can also boost residual income. You can speak to a financial advisor about how residual and passive income can play a role in your finances.

Passive Income Basics

Passive income is money earned without active involvement by the investor or owner of that money. Common sources of passive income include interest from savings accounts or bonds, dividends from stocks and rental income from real estate. Passive income can also come from royalties paid to an author, tuition fees charged to people who take an online course and interest in an I.O.U.

Passive income is highly valued by investors and retirement savers because it allows someone to increase their wealth without having to devote time, energy or funds to the effort. If passive investments produce enough money, an investor may be able to retire early. Passive income can also reduce the risk of hardship due to interruptions to sources of earned income, such as wages and salary from a job.

Residual Income Basics

passive income vs residual income

Residual income can have different definitions in different areas of business but in personal finance, it refers to the amount of money an individual has remaining after paying for living expenses. For instance, if someone receives $5,000 in monthly income from all sources and pays a total of $4,000 for all expenses including rent or mortgage, auto or other loans, food, utilities, etc., their residual income is $5,000 minus $4,000 or $1,0.00.

Having a healthy level of residual income is important when seeking credit since lenders want reassurance that a borrower has enough disposable income to make the loan payment. Residual income can also let someone pay down high-interest debts, build emergency savings or start investing. If nothing else, having money left over at the end of the month supplies peace of mind.

Unlike passive income, the source of residual income doesn’t matter. It can come from wages and salary from working at a job, passive income from dividends or savings or any other source.

Boosting Residual and Passive Income

Increasing residual income involves either increasing overall income, reducing expenses or both. To increase income, a wage-earner may request a raise from the employer, take a second job or sell unused assets such as excess furnishings. Residual income can also be increased by generating passive income, such as by investing in dividend-paying stocks.

Reducing expenses can effectively increase residual income even if overall income doesn’t change or even declines modestly. People can cut costs to boost residual income by reducing entertainment subscriptions such as cable television, paying off a high-interest credit card, shopping for better rates or insurance or moving to a less costly home, perhaps in a different area.

Passive income can come from many sources. Some of the most popular include investing in dividend-paying stocks, depositing money in interest-bearing accounts and investing in residential real estate. Some passive income activities require some attention and effort, such as managing real estate. You can collect more passive income by using residual income to invest in new income-generating investments or exchanging current investments for new ones that earn better yields.

The Bottom Line

passive income vs residual income

Residual income and passive income can be important considerations for anyone trying to increase financial stability and pursue long-term financial goals. Residual income, which is money left over after paying living expenses, is often carefully evaluated by lenders before granting credit. Increasing residual income often involves generating more money from a job or other sources and may mean reducing expenses as well. Passive income is money generated without much effort or ongoing investment of time and attention. It can include interest from savings accounts or bonds, dividends from stocks and rental real estate.

Tips for Budgeting

  • Financial advisors help people with budgeting, saving, investing, planning for retirement and more. If you don’t already have a financial advisor it doesn’t have to be difficult to find the right one. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Budgeting is a critical skill for calculating and managing residual income. Use SmartAsset’s free online budget calculator to get an estimate of what similar households in your neighborhood spend on common items such as housing, child care and food. Then input your own expenses by category to see how you stack up and perhaps highlight opportunities for savings.

Photo Credit: ©iStock.com/Viorel Kurnosov, ©iStock.com/NosUA, ©iStock.com/PavelKriuchkov

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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