Table of Contents:
- Passive Income vs. Residual Income
- Residual Income Formula and How It Works
- Different Types of Residual Income
- How To Make Residual Income
- The Bottom Line
If you’ve ever looked for a way to make a little extra money, you may have come across the term residual income, which is the money left over after all bills are paid. Personal finance refers to the income received after the initial work has been completed.
For example, when you purchase a house as a rental property, the rent paid should be enough to make the mortgage payment and any maintenance on the property every month. Whatever cash is left over is residual income.
- Passive income is earned with little ongoing effort once the work of creating the project is completed.
- Residual income is the cash you have available from your income sources once all debts have been paid. A formula is used to make that determination.
- Residual income can come from a variety of income-earning activities.
Passive Income vs. Residual Income
Although sometimes used interchangeably, passive income and residual income are not the same. They are both a type of income generated but work differently. While passive income is earned from an activity or business with no ongoing effort necessary, the residual income definition states that residual income is income one continues to receive after completing income-producing work. One thing to keep in mind is that although residual income can be earned passively, passive income isn’t always residual.
One of the reasons we are so interested in making passive income is because it’s done with little to no effort. Both individuals and companies engage in earning passive income from activities such as peer lending, silent partnerships, and investing. The IRS calls passive income money earned from an entity with no direct involvement.
A phrase used frequently when discussing passive income is making money while you sleep. It can be hard to believe, but it is possible. Since the one thing we all have in common is time, this is appealing. We each get 24 hours in a day and no more. Most of us spend our days working at a job, and despite working hard to get ahead, inflation rises much too quickly for us to achieve that goal.
Of course, passive income isn’t easy to attain. In the beginning, there will be a lot of work involved and probably a learning curve to add even more difficulty to the task. However, ask anyone who has achieved it, and they will tell you it was all worth it. After all, wouldn’t it be great to have more control over your time without worrying about money?
Passive income gives those who earn it the ability to make money while doing other things, even sleeping. Having a passive income stream offers a variety of benefits including:
- Supplemental income – Income earned on top of your regular income from employment that offers the breathing room we all seem to need.
- Financial stability – Having money come in automatically allows you to reduce the anxiety of paying expenses and offers time to learn more about other ways to grow your money.
- It’s not tied to your time – You’re able to earn money when not actively working, allowing more freedom to do what you like.
Having a passive income stream is a way to earn money to pay down debt, save for a home, travel, and other activities that may be out of reach. Many people interested in passive income are ultimately looking to replace the income they receive from a job in search of the financial freedom so many of us crave.
To define residual income, it’s income you continue to accumulate after you have taken part in an activity that can produce income. For example, residual income is dependent on the completion of a project before seeing any returns. This allows you to plan, produce, and execute your project on your own time.
Earning residual income offers the same benefits as passive income, as it’s also a form of passive income. It’s the process that differs.
Residual Income Formula and How It Works
Residual income can apply to both personal finances and business operations, so we’ll cover both. When calculating personal income, the formula is:
Monthly take-home pay – monthly debt = residual income.
Why is it important? In personal finance, the formula is used to calculate the affordability of a loan, usually a mortgage. In other words, does the borrower make enough money after bills are paid to afford the loan payment? If not, they will not be approved.
For example, let’s say Bob is in the market to purchase a new boat. His take-home pay is $3000 a month. His bills include his rent, which is $1200, his car, which is $200, and his camper, which is $250.
Using the formula, Bob’s residual income (RI) is $1350
$3000 – $1650 = $1350
The bank would determine the purchase price of the boat and monthly payments to determine whether Bob can afford the boat.
When talking about investments, residual income comes from a passive income source, meaning that it’s earned without any direct work from the investor. To put it simply, the investment itself creates more income. The beauty of it is that you can invest money in the stock market, and it continues to produce dividends without any additional input. This is why investing is such a valuable tool for growing wealth. Learn more about investing with little money and get some investing tips for beginners.
In business, accountants define residual income as the total number of operations revenue that is left over after costs are paid that exceed the minimum required return.
The business formula is:
Residual income = net income – (minimum required return x cost operating assets)
The equation is simple yet powerful for managers because it highlights the rate of return, which is an essential component of making important department decisions. It helps management see whether the business is making enough money to continue, expand the business, or close its doors, if necessary.
Different Types of Residual Income
When exploring how to build wealth, residual income is a valuable tool. Here are three types of residual income.
Equity valuation is used to determine the actual value of a company’s equity in order to make solid financial decisions. The equity is driven by how the company does business day to day over time.
One of the business models used is the discounted cash flow (DCF) approach. It’s a method used to estimate an investment’s value based on expected future earnings. It can assist investors when making decisions about investing in a company’s stock, purchasing a company, and other financial choices based on the intent of the user.
Residual income in the corporate world is also known as the net operating income that exceeds its required rate of return. It’s any profit that remains after all capital costs are paid and are used to determine business performance.
When discussing personal finance, residual income is also called disposal income, which can be seen using the personal finance calculation described above. When applying for a loan, the more residual income you have, the better the chances are of getting the loan.
How To Make Residual Income
By now, we’d bet you may be warming up to the idea of residual income and are curious about how you can start making it. The good news is that there are plenty of residual income ideas and ways to go about it, so let’s get started!
- Pay off debts
We all know that high-interest credit cards and other debt payments can feel like you’re dumping money into an endless hole with nothing to show for it, so paying them off can make a big difference in your income.
There are a few approaches to paying off debt. Still, one that’s pretty motivating is paying them off smallest to largest, as paying off your smaller debts gives you the boost to keep going until you become debt-free. Once you eliminate a debt, you use the money you were paying on that debt and add that amount to your next debt, increasing the payment and accelerating your payoff.
Another popular payoff plan is to tackle the high-interest debt first and then move to the next one until you get them all paid off. Either way, becoming debt-free not only feels amazing, but it also allows you additional income to put into other residual income streams.
- Invest in dividend stocks
Investing in the stock market offers two ways to earn residual income. The first is buying stocks and, if they go up in value, the value of your portfolio increases; the second is through dividend payments. There are a variety of publicly traded companies that pay shareholders regular dividends, usually on a quarterly basis.
Buying stocks in a well-established company with good cash flow can also provide you with dividends regularly. Check the S&P 500 and the Dow Jones Industrial Average to find companies that pay dividends.
- Peer-to-peer lending (P2P)
We’ve all lent money to someone we know, but over the years, peer-to-peer lending has been a popular option for earning residual income. You can find various platforms that connect those individuals looking for a loan with those who can provide the money they need to fund projects that traditional lenders won’t approve of.
As a lender, P2P investing offers an opportunity to earn more from the interest your borrower pays than you can in a savings or money market account. But it’s important to understand that there are risks associated with it, so be sure to check the platform for any vital information regarding how you get paid, the time frames, and any guarantees or protections involved.
- Sell on online marketplaces
Selling stuff online has exploded over the years with no end in sight. And with so many marketplaces, this can be a very profitable source of residual income. Marketplaces are making it easy to list and sell, and with a bit of creativity, you can be up and running in no time.
It doesn’t matter if you are new to online selling or have been in it for a while, ease of entry is simple, and there are plenty of marketplace options. Here are a few of the most popular places you’ve already heard of:
The great thing about selling on online marketplaces is that you can sell your goods without the need to have your own store and it provides a flexible opportunity with low start-up costs. The popularity of the marketplace also always has potential customers coming to the site.
- Rental Property
Whether you have an extra room, an apartment above the garage, a vacant home, or an Airbnb, renting can provide a nice residual income. While there are responsibilities in renting, there are also some benefits that certainly can make it worthwhile.
- Cash flow – as a landlord, you’ll receive a regular income each month from your renters.
- Tax benefits – there are a variety of deductions that you can take as a landlord, including repairs and depreciation.
Rentals aren’t limited to homes or apartments either. Some companies allow individuals to take part in sharing their cars, boats, and even airplanes, which can all provide residual income.
Another way of investing in property is through REITs or real estate investment trusts.
- Informational products
One of the most popular ways to make a residual income is by generating information. It’s become more accessible than ever to distribute information products, and it’s easy to get started. All that’s needed is an idea and the time to plan and create your product.
Informational products are educational and offer the customer a way to learn something that can benefit them in some way and provide value.
Most of us know something that others need or want to learn. The key is putting all that knowledge into an easily digestible format that allows you to share it in a way that makes sense. Think about the way you get the information you want.
- Do you prefer to read an ebook or a printed book?
- Take an online course?
- Watch videos online?
There are various ways to provide information, and each has a platform to make it easy to do. Some ideas include:
- Webinars and podcasts
- Online courses
- Membership sites
All of these products can be sold digitally online, and when you make a sale, you receive residual income.
- Stock photos
Content marketing has boosted the need for photos to add to websites, blogs, and online articles. As the demand has grown, so have the opportunities to sell your images. In addition, several platforms offer easy setup, accept payments, and even deposit commissions into your bank account.
- App developer
Apps are more popular than ever, and if you’ve got the coding skills, developing apps can be a great way to earn a residual income. Cell phones have made using apps the norm, and there are apps for just about anything you can think of. But if you have an idea that fills a niche and makes something easier to do, you may want to give apps a shot.
The Bottom Line
In our busy world, it can be challenging to find time to do much beyond work, making getting ahead financially seem out of reach. But the good news is that there are ways to make residual income with a little time and effort, which could reward you for years to come.
Investors have an edge in building wealth, where trading time for money is taken off the table. Dividends and the power of compound interest are two ways that investing builds wealth for those who want to achieve it. The Public app can help you take your first steps to building wealth today!