What are the 7 streams of income? Have you ever heard that millionaires typically have seven sources of income?
I tried unsuccessfully to locate the survey, report, or official reiterating that statistic. That being said, I think seven is a good number.
More importantly, how will we obtain them? (If you want to get started right away, here are some great passive income ideas)
This blog post was inspired by an idea proposed by my friend at ESI Money, who discusses how the first million is the most difficult. ESI discusses how his net worth has increased. The first million dollars required 19 years of work (the clock starts when he starts working, not when he is born!) However, the second million took only 4 years and 9 months.
The more you have, the more money you will receive. A dollar is equal to 1% of $100. A cool grand is 1% of $100,000.
The rich do get richer – here’s how it’s done.
Active versus passive income
Let’s start with how you make money, or your income.
Active and passive income are the two types of income.
When you work and are paid for it, you have active income. If you work at McDonald’s, you are paid by the hour. If you work in an office, you may not clock in and out, but you are paid based on the amount of work you complete. You will no longer be paid if you do nothing.
Passive income is defined as income that is not directly related to active work. Passive income includes things like interest and dividends. The majority of passive income sources are front-loaded with active work for which you are paid a small amount, with the majority of the income coming later.
Don’t confuse passive income with no work. It’s a common misconception about passive income.
It’s still working; it’s just that your pay isn’t directly proportional to the number of hours you put in. Anyone who owns rental properties understands that it is considered passive income, but there is a significant amount of work involved. The work is front-loaded, but if you’re lucky, you’ll be able to collect rental checks without incident for several months before having to do work.
My friend, for example, distributes monthly real estate investment reports. She made $7,461 on less than six hours of work in March 2016. She spent three weeks and $13,648 renovating a rental in July to increase her yearly income by $4,740. Rental income is passive, but it does require effort.
How do you amass wealth?
Here is the next piece of the puzzle.
The key to accumulating wealth is straightforward:
You can make money by selling your time.
You should spend less than you earn.
Invest your savings so that they will grow without your intervention.
That’s all. It’s a straightforward input/output problem. It’s also what separates the wealthy from the rich.
The entire system is constrained by only one factor: your time in this world.
You only have 2.21 billion heartbeats. At 60 beats per minute, that’s slightly more than 70 years. Every beat counts.
Maslow’s Hierarchy of Needs is another constraint, and this is where wealth inequality begins to show its ugly head.
You must eat. You require a place to sleep. And both of these, as well as other requirements, necessitate the expenditure of funds.
In an ideal world, you could take your time building a massively successful business (or perhaps a few failures before the massive success), but in the real world, you need a job that will pay you right now so you can feed yourself, clothe yourself, and find a place to sleep.
It’s what I call financial gravity.
Give Personal Capital a look if you want to really start tracking your finances, not just your spending but also your investing (which is where wealth is built). It’s a pillar of my financial system, and I believe you should take a look. It’s also completely free.
You are subject to economic gravity.
Consider your net worth to be an airplane. You’re attempting to launch it into the sky and soar effortlessly.
We are all subject to the same gravitational force on Earth. The greater your size, the more force that force exerts on your body. You’d fly away if you weighed nothing.
Our net worth aircraft are all subject to the same financial pull. The size and weight of your plane will be determined by where you choose to live, how you choose to live, the products you buy, and so on. The greater the need (monthly expenses), the greater the thrust (income) required.
When your thrust (income) exceeds your gravity, your net worth airplane takes off (expenses).
There will also be a point where it will look less like a plane and more like a rocket. It is when passive thrust takes precedence over active thrust. Ideally, your investments will grow to the point where they have the greatest impact on your net worth and your income and savings (income minus expenses) will play a smaller role.
That transition point can be difficult to navigate, but it is also very liberating.
First, increase your active income.
If you don’t have any other resources, you should begin by focusing on active sources of income (job) until you’ve saved enough to build up passive resources.
There are two schools of thought when it comes to saving money:
Save more- This school emphasizes living “frugally” and keeping your expenses to a bare minimum.
Earn more- This school emphasizes earning more through side hustles, businesses, and other means.
It’s a skewed dichotomy. You can, and you should, do both.
The difference is that cutting expenses, like active income, is immediate, whereas earning more is often a long-term play, like developing passive income sources. So you cut what you can now (for example, cut your cable) to save money while you build up your passive sources (e.g. put cable savings into dividend stocks).
The significance of saving money, particularly early in life, cannot be overstated.
When you start with nothing or almost nothing, you are forced to work. What you are able to save can be turned into passive income. If you don’t save that active income, whether by choice or by force, you’ll be stuck in that phase indefinitely and never reach financial freedom.
Many of these passive income sources, such as qualified dividends and long-term capital gains, are also taxed extremely favorably. If you are in a low tax bracket, your capital gains may be tax-free. If you are in a high tax bracket, the rate is only 15%, which is significantly lower than ordinary income tax rates.
Then, expand your passive income.
Each passive stream, in my opinion, falls into one of two categories:
You create something (a business) that adds value and then capture a portion of that value.
You lend money to someone who will build something valuable, and they repay you.
Savings are required in both cases.
When you start a business, you give up current active income (instead of working for pay, I volunteer at my own business) in exchange for future active and passive income. In the meantime, you’ll need a way to pay your bills. It’s possible that you’re working a day job while building a side business, or that you’re living off your savings. You’ll need a cushion in either case.
When you lend money, you are lending your savings to someone who will work hard to grow it into more.
Savings are required for all of those potential future passive streams.
What Are the 7 Streams of Income?
Earned income is money earned from a job. You could, for example, be paid an annual salary, an hourly rate, a commission, or money from self-employment.
Earned income is taxed at your regular tax rate, and it must be reported to the IRS at tax time. You pay taxes on earned income as you go, with your employer deducting the funds directly from your earnings before issuing your paycheck and paying the taxes on your behalf.
If you work for yourself, you must pay taxes to the IRS on a quarterly basis based on your estimated tax liabilities.
Earnings from Profits
Profit income is income earned from your business. Profit income includes any goods or services that you sell for a profit. Because this type of income is not guaranteed, budgeting is more difficult. To earn it, you must sell products or services at a profit. Most businesses experience peaks and valleys in their revenue.
With interest rates so low, interest income isn’t something you should rely on, but it is one of the passive income streams that can add up and help you meet your financial goals.
High-yield savings accounts, regular savings accounts, checking accounts (only some pay interest income), CDs, and money market accounts can all provide interest income.
Income from Dividends
Dividends are your share of a company’s profits if you own a stake in it. Dividend income can be obtained from stocks, ETFs, and real estate investment trusts. However, there is no guarantee that a company will pay dividends, so don’t rely on it as your primary source of income; instead, combine it with your other income streams to reach the ideal 7 streams to achieve financial independence.
You can earn rental real estate income by adding real estate investments to your portfolio. This is the money you receive from tenants who rent out your properties, whether residential or commercial.
Rental income, like most other sources of income, should not be relied on because there is always the risk of vacancies or tenants who fail to pay their rent. However, your rental income will most likely be used to pay mortgage payments (to finance the properties), property taxes, insurance, and maintenance costs.
Profits from rental properties are taxed, so keep that in mind when pricing your rental properties, as rental income is an ordinary income stream.
Income from Capital Gains
When you sell an asset for more than you paid for it, you can earn capital gains. For example, if you buy a home for $100,000 and sell it for $200,000, your capital gains are $100,000. Other assets, such as businesses, stocks, antiques, and art, can also generate capital gains.
Capital gains are typically taxed as they are received, so if you earn $100,000 when selling a house, you will most likely owe taxes on all or a portion of the proceeds.
Income from Royalties
If you have copyrighted content that you can share, you can earn royalties on each sale. Take music, for example. If you wrote a song and released it, you’d earn royalties every time someone bought a copy of it.
You can earn royalties on your ideas or products created using your ideas even if you are not a musician or artist.
The Advantages of Having Seven Income Streams
Seven income streams or multiple income streams can help relieve the pressure of having enough money to meet your financial goals. Whether you want to be a millionaire or just have financial peace, having multiple sources of income can help you achieve your goals while still enjoying life.
You will no longer have to rely on your earned income to get through financial emergencies, forcing you to choose between paying your bills and dealing with the emergency. You won’t have to worry about depleting your retirement savings or other funds set aside for other purposes just to get by.
With seven sources of income, you have a much better chance of accumulating wealth and reaching your financial objectives. You’ll think outside the box, take risks, and reap the benefits.
When you get caught up in the 9 to 5 rat race and only focus on that, you miss out on many opportunities to generate income, capital gains, and even invest in the stock market to see much greater rewards than you would if you only focused on your job.
Find out more about How Many Streams of Income Should You Have.