Learning how to invest is an important part of becoming financially free.
Good thing that it’s not that hard to start investing today.
However, many fail to understand how investments work, particularly, in terms of how it makes money.
At the most basic level, your investment income comes in three forms. First, as capital gains; second, as earned (or active) income; and third, as passive income.
Knowing the differences between these three, and being able to analyze how each of your investment earns, can be a valuable guide in achieving balance in your investment portfolio.
Investments are often categorized by its risk type – zero, low (conservative), moderate and high (aggressive).
A time deposit, for example, is a zero risk investment. And without considering the effects of inflation, your money in a time deposit account will always appreciate.
Meanwhile, with the other three, your money can go either up, or down. The level of risk dictates how much your investment could potentially gain (or lose).
Now let’s consider the three forms of income you get from investments:
- Capital Gains
- Earned Income
- Passive Income
These are investments that you buy because you hope that its value will go up in the future, so that you can sell them for profits. A good example of this would be the income you get from investing in toy collectibles. Your time deposit account, is also an example.
These are investments that you buy because they have the potential to give you income BUT ONLY if you would actively work for it. Enrolling yourself in a baking class is an investment of both time and money, and it will give you earned income in the future, by selling cakes and cookies for example.
These are investments that you buy and “forget”, because these give you income regardless if you work or not. A good example would be dividends from investing in a private company or the income you get from a business that’s running on its own.
Wealth managers would often say that you should diversify your portfolio. This simply means spreading your investments across zero, low, moderate and aggressive types of instruments. And that’s just what many people do.
But one thing that many forget to consider is the form of income you get from these investments. This is the one critical investing mistake that you might not know you’re making.
Investing in instruments that give capital gains and earned income may not be enough to help you achieve financial freedom. You need passive income to make everything else happen.
Having a time deposit account, a moderate-risk mutual fund investment and several stock market shares certainly looks like a risk-diversified portfolio. But when it comes to income-type, all three primarily just gives you capital gains and very, very little passive income.
It’s the same thing with having an office job, running an online store business and freelancing on the side. You’re doing pretty well when it comes to having multiple sources of income, but all three are mainly earned income types.
Investing in capital gains secures your future, but it does not pay your bills today. Meanwhile, earned income does pay your bills, but it could drive you to exhaustion in the future.
Investing in passive income does not only pay your bills today, but also gives you the time freedom to do more and enjoy life more.
Lastly, I’m not saying that investing in capital gains and earned income is bad. I actually think you should invest in those types of income always.
What I am saying is that you should not forget to invest in building passive income as well. You should invest in assets that give you regular income, without much or very little effort on your part.
So the question now is, what are those types of investments that give good passive income? Well that’s going to be the topic of another article here very soon.
In the meantime, I hope you can subscribe to Ready To Be Rich, it’s free and it will guarantee that you won’t miss that post when it comes out.
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