Understand the Three Kinds of Income

Updated: Apr 5

Not all income is created equal. Learn about different types of income and develop a strategy to build wealth more quickly.

Most people are taught to pursue a good job that provides a good income so they can have financial security. But the income that comes from your job is only one kind of income, and it's not usually sufficient by itself for building long-term wealth. You need to start by asking the question: what are the three types of income? Then you need to consider how to create different kinds of income.

"If you don't find a way to make money while you sleep, you will work until you die." Warren Buffet

1. Earned Income

Earned income is the sort of income most people know, and it's the sort of income most people pursue. Whether you are working minimum wage at a fast food restaurant or have a six figure salary at a bank, the money in your check represents earned income. It's reported on your W2. As Robert Kiyosaki says in Rich Dad's Guide to Investing, "When you say to a child, 'Get a good job,' you are advising the child to work for ordinary earned income" (121). You are also advising that child to focus on the path that comes with the highest percentage of income taxes. That's right! Of all the types of income, earned income is taxed at the highest rate. And that's one of the reasons it's difficult to build substantial wealth exclusively on earned income. The government takes a large portion of it.

2. Passive Income

Passive income is income that requires little or no effort to keep it coming. You'll have to do some work at the start to get the income stream going. But once the structure is in place, there's not much for you to do. For example, if you purchase a rental property and put it with a property manager, then the manager does all the work to keep the property in operation and you get the profits. Also, unlike earned income, money made from real estate holdings is taxed at a much lower rate. Some people use a blog or website to create passive income. Monetized YouTube videos create passive income. You do the work up front, and the video stays out there forever. The more people watch it, the more passive income it creates.

3. Portfolio Income

Portfolio income is money you get from paper assets like stocks or exchange traded funds. Portfolio income is like passive income in that you don't have to do anything to maintain it, though you probably want to pay attention to the health of the companies you invest in. One strategy would be to invest primarily in stocks that pay quarterly dividends. That means the company in which you own shares of stock pays part of the earnings to you four times a year. You typically have the option to take the cash or to reinvest that cash in more shares of stock. If you opt to reinvest the dividends, then you do nothing and your share of that company increases over time.

A Strategy

Billionaire businessman Warren Buffet once famously said, "If you don't find a way to make money in your sleep, you will work until you die." When he said that, he was talking about finding ways to make passive income and portfolio income. Because those types of income pay all the time, even while you sleep. So how do you do it? Here's one strategy. Set aside a part of your earned income and invest it in passive income and portfolio income. Now you're not just spending money; you're investing it. And that's how you build your wealth.

Now find out what you have to buy to build wealth.

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This content is for educational purposes only and should not be considered financial advice. This page may contain affiliate links to products. We may receive a commission for purchases made through these links.


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