Buzz
The idea of making money without active effort is appealing. When people talk about ‘earning money while you sleep’ (even though that’s a myth), they’re typically referencing either passive or residual income. While these terms are often used interchangeably, they do have distinct differences. Here’s an overview of what separates passive and residual income, and how they can help you earn extra cash.
What does passive income mean?
In essence, passive income is exactly what it sounds like: money that comes in without the active labor of a regular job. This type of income begins after you invest either time or money upfront, with little ongoing effort once that initial commitment is made.
Some examples of passive income include renting out an extra room via a home-sharing app or selling clothes online. However, many things that are labeled as passive income (such as real estate, book royalties, online sales, etc.) actually require much more work and continuous effort than what most financial experts would have you believe.
What exactly is residual income?
As defined by Investopedia, residual income carries three different meanings based on context—personal finance, corporate finance, and equity valuation. When it comes to personal finance—our main focus here—residual income refers to any income left over after all debts and bills are paid. If you’re applying for a loan, this leftover income is used to assess your ability to repay. It's essentially the same as discretionary income.
This definition suggests that residual income is often passive. However, this doesn't mean all passive income is residual. In fact, the extra income you earn from your main job could help fund a new passive income venture. Both passive and residual income are subject to taxes, but they are taxed differently compared to active income.
To sum up
Both residual and passive income can enhance your financial stability, but passive income will likely have a bigger impact, as noted on Indeed.com. Here’s an example: Imagine you pay all your bills and reduce your debt by $500 one month, generating $500 in residual income. If you also rented out a vacation property during that time, you could have earned over $1,000 in passive income—definitely a more substantial increase. Of course, the real question lies in how you define "passive" when it comes to managing and renting out that property.
In the end, when people talk about earning extra cash with minimal effort, they’re generally referring to passive income rather than residual. You may need residual income to get your “side hustles” started, and from there, passive income can help increase your overall residual income—all the money left after covering your bills.
