personal finance

 One of many keys to getting rich and creating wealth is to comprehend different ways by which income may be generated. It's often stated that the low and middle-class work for money whilst the rich have money work for them. The key to wealth creation lies within this simple personal finance.

Imagine, rather than you working for money that you instead made every dollar do the job 40hrs a week. Better yet, imagine each and every dollar working for you 24/7 i.e. 168hrs/week. Determining the very best ways you can make money do the job is an important step on your way to wealth creation.

In the US, the Internal Revenue Service (IRS) government agency accountable for tax collection and enforcement, categorizes income into three broad types: active (earned) income, passive income, and portfolio income. Anything you ever make (other than maybe winning the lottery or receiving an inheritance) will fall under one of these simple income categories. In order to discover how to become rich and create wealth it's vital that you understand how to generate multiple streams of passive income.

Crossing the Chasm

Passive income is income generated from a trade or business, which doesn't require the earner to participate. It's often investment income (i.e. income that's not obtained through working) however not exclusively. The central tenet of this sort of income is that it can get to carry on whether you continue working or not. As you near retirement you are almost certainly seeking to restore earned income with passive, unearned income. The secret to wealth creation earlier on in life is passive income; positive cash-flow generated by assets that you control or own.

One of many reasons people find it difficult to really make the leap from earned income to more passive sourced elements of income is that the entire education system is really virtually designed to teach us to accomplish employment and hence rely largely on earned income. This works for governments as this type of income generates large volumes of tax but won't do the job if you're focus is on the best way to become rich and wealth building. However, to become rich and create wealth you will undoubtedly be necessary to cross the chasm from depending on earned income only.

Real Estate & Business - Sources of Passive Income

The passive type of income is not influenced by your time. It's influenced by the asset and the management of this asset. Passive income requires leveraging of other peoples time and money. For instance, you could purchase a rental property for $100,000 utilizing a 30% down-payment and borrow 70% from the bank. Assuming this property generates a 6% Net Yield (Gross Yield minus all Operational Costs such as insurance, maintenance, property taxes, management fees etc) you would generate a net rental yield of $6,000/annum or $500/month. Now, subtract the price of the mortgage repayments of say $300/month from this and we arrive at a net rental income of $200 from this. That is $200 passive income you didn't have to trade your own time for.

Business can be a source of passive income. Many entrepreneurs start off in operation with the idea of starting a business in order to sell their stake for a few millions in say 5 years time. This dream will simply become a reality if you, the entrepreneur, could make yourself replaceable so the business's future income generation is not influenced by you. If you can do this than in a way you have created a source of passive income. For a business, to become true source of passive income it takes the proper sort of systems and the proper kind of people (other than you) operating those systems.

Finally, since passive income generating assets usually are actively controlled by you the owner (e.g. a rental property or perhaps a business), you have a say in the day-to-day operations of the asset which could positively impact the degree of income generated.

Passive Income - A Misnomer?

For some reason, passive income is a misnomer as there's nothing truly passive about being accountable for several assets generating income. Whether it's a house portfolio or a business you have and control, it's rarely if ever truly passive. It'll need you to be involved at some level in the management of the asset. However, it's passive in the sense that it doesn't require your day-to-day direct involvement (or at the least it shouldn't anyway!)

To become wealthy, consider building leveraged/passive income by growing the size and level of your network in place of simply growing your skills/expertise. So-called smart folks may spend their time collecting diplomas and certificates but wealthy folk spend their time collecting business cards and building relationships!

Residual Income = A Kind of Passive Income

Residual Incomeis a form of passive income. The terms Passive Income and Residual Income in many cases are used interchangeably; however, there's a simple yet important difference between the two. It's income that's generated from time to time from work done once i.e. recurring payments that you get long after the initial product/sale is made. Residual income is normally in specific amounts and paid at regular intervals. Some exemplory instance of residual income include:-

- Royalties/earnings from the publishing of a book.

- Renewal commissions on financial products paid to an economic advisor.

- Rentals from a house letting.

- Revenue generated in multi level marketing networks.

Utilization of Other People's Resources and Other People's Money

Utilization of Other People's Resources and Other People's Money are key ingredient necessary to generate passive income. Other People's Money buys you time (a key limiting factor of earned income in wealth creation). In a feeling, use of other people's resources gives you back your time. As it pertains to raising capital, businesses that generate passive income usually attracts the biggest quantity of Other People's Money. This is because it's generally possible to closely approximate the return (or at the least the risk) you are able to expect from passive investments and so banks etc., will often fund passive investment opportunities. A great business plan backed by strong management will usually attract angel investors or venture capital money. And property can often be acquired with a tiny down payment (20% or less in certain cases) with the majority of the amount of money borrowed from a bank typically.

Tax Great things about Passive Income

Passive income investments often allow for the absolute most favorable tax treatment if structured correctly. For instance, corporations can use their profits to purchase other passive investments (real estate, for example), and avail of tax deductions in the process. And property may be "traded" for larger property, with taxes deferred indefinitely. The tax paid on passive income will vary on the basis of the individual's personal tax bracket and corporate structures utilized. However, for the purposes of illustration we will claim that typically 20% effective tax on passive investments will be a reasonable assumption.

In conclusion:

For valid reason, passive income is usually considered to be the holy grail of investing, and the key to long-term wealth creation and wealth protection. The major advantage of passive income is that it's recurring income, typically generated month after month without a lot of effort by you. Building wealth and becoming rich shouldn't be about extracting every last bit of your personal energy, your own personal resources and your own personal money as there's always a limit to the extent you can do this. Tapping into the effective generation and use of passive income is a critical step on your way to wealth creation. Begin this element of you wealth creation journey as early as is humanly possible i.e. now!

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