What Is Residual Income?
If youve ever looked for a way to make extra money, you may have come across the term residual income. In personal finance, residual income refers to one of two things: either income received after the initial work has been completed, or the amount of money left over after all personal debts are paid off.
For example, when you purchase a house as a rental property, the rent paid by tenants should be enough to make the mortgage payment and any maintenance on the property every month. Whatever cash is left over is residual income.
Or, if youre a musician who receives royalties years after you wrote a song, this is also a form of residual income referred to as passive income. Investing in a residual income stream can be a great investment strategy, so lets get started learning how it works and how to earn it.
Table of Contents:
- What Is Residual Income?
- Residual Income Formula and How It Works
- The Difference Between Passive Income and Residual Income
- Different Types of Residual Income
- How To Make Residual Income?
- The Bottom Line
- Frequently asked questions
Key Takeaways:
- Residual income is measured using a formula to determine the cash you have available from your income sources once all debts have been paid. Well explain the ins and outs of this formula.
- Passive income is earned with little ongoing effort once the work of creating the project is completed. Learn how this is distinct from other forms of residual income.
- Residual income can come from a variety of income-earning activities. Well explain what they are and how to get started yourself.
Residual Income Formula and How It Works
Residual income can apply to both personal finances and business operations, so well 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. Or, if the bank determines its risky, the lender may attach a higher interest rate or require a higher downpayment upfront.
For example, lets 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, Bobs 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 its 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. When you invest with Public, you can access features like Public Townhall where youll get updates of publicly traded companies directly from founders and c-suite executives to understand fundamentals of the business and invest in asset classes you truly believe in. Learn more about getting started 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.
The Difference Between Passive Income and 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 isnt always residual.
Passive Income
One of the reasons we are so interested in making passive income is because its 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 isnt 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, wouldnt 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.
- Its not tied to your time Youre 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.
Residual Income
To define residual income, its 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 its also a form of passive income. Its the process that differs.
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
Equity valuation is used to determine the actual value of a companys 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. Its a method used to estimate an investments value based on expected future earnings. It can assist investors when making decisions about investing in a companys stock, purchasing a company, and other financial choices based on the intent of the user.
Corporate Finance
Residual income in the corporate world is also known as the net operating income that exceeds its required rate of return. Its any profit that remains after all capital costs are paid and are used to determine business performance.
Personal Finance
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 bet youre warming up to the idea of residual income and are curious about how you can start making it to help reach your financial goals. The good news is that there are plenty of residual income opportunities and ways to go about it, so lets get started!
1. Pay off debts
We all know that high-interest credit cards and other debt payments can feel like youre 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. One thats 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 one, 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.
2. Invest in dividend stocks
Investing in the stock market offers various ways to earn residual income through dividend payments from dividend stocks. There are a variety of publicly traded companies that pay shareholders regular dividends, usually on a quarterly basis. To get started, check out Publics stock offerings.
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. For balance over time, you may consider factoring in dollar-cost averaging, or investing the same amount of money into the same stock or funds over a long period of time despite the highs and lows of the market. It can take discipline to take advantage of dollar-cost averaging, instead of reacting emotionally without foresight.
Quick Tip
Public makes it easier with features like Recurring Investing, which allows you to set up automated, consistent investments. You can also utilize Automated Dividend Reinvesting, which will reinvest your dividend payments into more stock. Both of these features help you accumulate more money over a long period of time, without even thinking about it.
3. Peer-to-peer lending (P2P)
Weve 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 borrowers with those who can provide the money they need to fund projects that traditional lenders wont 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 its 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.
4. 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 doesnt 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 youve 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. You can sell as little or as much as you want, making it a great side-hustle opportunity. The popularity of the marketplace means potential customers are always coming to the site.
5. 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, youll 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 arent 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 real estate investment trusts. What are REITs? In short, a company that owns often operates income-producing real estate. Like a mutual fund for housing.
6. Informational products
One of the most popular ways to make a residual income is by generating information. Its become more accessible than ever to distribute information products, and its easy to get started. All thats 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:
- Ebooks
- Webinars and podcasts
- Starting a Youtube channel
- Audiobooks
- Online courses
- Membership sites
All of these products can be sold digitally online, and when you make a sale, you receive residual income. Many people create communities for and market their informational products through social media platforms like Facebook.
7. 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 like Shutterstock offer easy setup, accept payments, and even deposit commissions into your bank account.
8. App development
Apps are more popular than ever, and if youve 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!
Frequently Asked Questions
How do you get residual income?
From setting up a side hustle by making a Youtube channel, to turning residual income from rental properties into your primary way of making money, there are many different ways to get residual income. You can grow residual income by investing in stocks, ETFs, crypto or alternative investment classes. With Public, you can make wise investment choices by using social network investing to easily keep a tab of ever-changing markets and understand market sentiments.
Is residual income legit?
Yes! Residual income is a completely legitimate way of making money. However, depending on the type of residual income you choose, there may be upfront cost of capital to consider, which may mean that particular income stream doesnt work for you.
What is the residual income of a commission?
A residual commission is any commission that a salesperson earns after the client makes their initial purchase. This applies to ongoing accounts, where a companys revenue model allows a sale to continue to generate revenue.
What is active income?
Active income, also called earned income, is an amount of money earned from tasks performed: salary, tips, commissions, etc. Earning active income requires actively putting in effort and takes up your time. Active income is the most common way of making money.
How are passive income and residual income taxed?
Passive income and residual income are taxable, often at your ordinary tax rate based on your income bracket. Public does not offer tax advice.