Updated: February 16, 2022
Financial security comes from having multiple sources of income. However, it’s also important to have diversity in the types of income that you have.
For instance, working on a full-time job and two part-time jobs will give you multiple sources of income. But imagine how your life is if that’s the case; I’m sure you’re always exhausted from all the work you’re doing.
What if instead, you have a full-time job, an apartment rental, and an online business. You also have multiple sources of income, but your days aren’t as hectic as our first case, right?
This is what I meant about having diversity in the types of income that you have.
The Different Types of Income
Income can be described under different types. But today, we’re only interested in four types.
The most popular is the dichotomy between active and passive income.
- ACTIVE INCOME: Income that requires work. To earn, you need to spend time and effort. It’s you working for money. Example: a job salary.
- PASSIVE INCOME: Income that requires no or little work. To earn, you simply have to wait. It’s money working for you. Example: dividend income from an investment.
Less popular, but equally interesting, is the spectrum of linear and residual income.
- LINEAR INCOME: Income that you can earn only once. Work and then receive a one-time income. Example: profits from a buy-and-sell transaction.
- RESIDUAL INCOME: Income that you can earn multiple times. Work and then receive income from it again and again. Example: royalty payments from a book you wrote.
The Income Matrix
A few months ago, I had this idea of plotting these types of income on a plane. The vertical axis would be the ACTIVE and PASSIVE range, while the horizontal axis would be the LINEAR and RESIDUAL array.
After doing so, I described the types of income that the intersections would produce. And this is what I came up with:
The intersection between ACTIVE and LINEAR income. Income that’s earned here usually becomes the capital for other ventures. It’s the most accessible way to make money, that’s why it’s often the main source of income for a lot of people.
NET WORTH BUILDER
The intersection between PASSIVE and LINEAR income. It’s the space for long-term investments that appreciate in value over the years. This consequently helps build and increase your net worth.
The intersection between ACTIVE and RESIDUAL income. The sources of income in this area require a lot of work but you’ll be rewarded with continuous income afterward. The semi-passive nature of the cash flow allows you to build several sources of income here.
The intersection between PASSIVE and RESIDUAL income. It’s the quadrant for fixed-income instruments that continuously provide cash flow with little or no effort. However, you can rarely live off the income here, that’s why it can only serve as a supplementary source of cash flow.
Can you imagine where the different sources of income would place inside this plane? Here’s how I imagined it would look like:
Diversification in your Sources of Income
What have I learned from doing all these?
In the same way that diversification is good for our investment portfolio, I realized that having diversified sources of income is good for our cash flow.
It allows us to leverage our time and optimize our efforts, so we don’t work ourselves to exhaustion in building our wealth.
It all starts with earning CAPITAL INCOME to cover our necessary expenses. The surplus cash can then be funneled towards NET WORTH BUILDERS and sources of AUXILIARY INCOME. Finally, we learn to work smarter and not harder by creating INCOME BUILDERS.
In other words, spend less than what you’re earning so you can invest. And use your free time to work on projects or pursue ventures that will create semi-passive income, so you can invest more and secure your financial future.
If you’re a subscriber to this blog, then the graph above might look familiar. I already used that in a previous article and called it the Income Efficiency Plane.
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Fitz, a big thank you for this post. I must admit that while I have pictured graphs similar to what you posted in my daydreams, I never actually took it to the level of creating a physical graph. I guess I was working too much to reach my goals. These days, along with Beautiful Bride, we are doing our best to be sure our four troops are financially well educated. Rest assured this article will be shared and as we have done before. We have another great topic for our home education program. Only the little guy who is age 16 months will be exempt from the composition explaining what was learned and I will look forward to passing out monetary rewards (for the savings accounts) in exchange for exemplary work.
[…] Today’s post leans slightly towards personal finance because I was inspired by one of my favorite local personal finance bloggers who posted about the income matrix. […]