People need incomes to support themselves and their families and live a life of dignity. From a financial standpoint, income sources create opportunities for people to build assets, both physical and institutional, that can provide them with a steady stream of revenue. These incomes are primarily of two types: active and passive. What is active income and how does it differ from the concept of passive income?
Active income meaning
As the name suggests, active income is the fixed income that an individual generates by rendering certain services. Wages, salaries, and bonuses are the most common forms of this type of income. For instance, a financial analyst who works for a bank is paid a monthly pay check for their services, which becomes their active income. The concept applies to businesses, too. In the business world, this type of income refers to the profits generated by a company through the sale of its products or services or both. These profits are then used by the company to expand its operations and further expand its income sources. For salaried individuals, the monthly income allows them to build up their savings and invest in stable assets, such as real estate and gold.
Interpreting active income
The concept of active income is defined differently in different parts of the world. In the case of India, the term is understood simply as the income received from performing regular operations, such as working for a company or running your own business. The income needs to be shown to the tax authorities by filing returns and then the tax is levied on the income. For salaried people, this tax is cut before the income is credited to their account every month.
Active income vs. passive income
While active income denotes income received by individuals directly for the services they render, passive income is the form of income that individuals accrue by not participating actively in a business activity. This form of income primarily relies on returns from investments in diverse areas. For example, an individual buys an apartment and puts it up for rent. The monthly that they receive becomes their passive income. It cannot be considered an active form of income because the individual did not build the apartment or the building where it is located. Another example of passive income could be the royalties earned by authors after their work gets published and sold. Even in the case of salaried individuals, passive income can take the form of interest earned through fixed deposits. In simple terms, passive income complements active income and can provide solid financial support during crisis times, such as unemployment, or during old age.
Portfolio income
There is also a third kind of income called portfolio income and it is mainly applicable to investors and traders. The source of this income is also through investments, but these investments are primarily made in financial instruments, such as private equity, bonds, securities, and stocks. The income is received in the form of returns of different kinds, such as capital gains and dividends. It is difficult to categorise portfolio income as passive or active income, as, in several cases, transacting in the securities market is the primary service performed by investors. Similarly, for stockbrokers and other market makers, facilitating the buying and selling of assets is their main job. On the other hand, salaried individuals and self-employed people also participate in financial markets and earn passive income by investing in assets. Therefore, portfolio income is considered a separate type of income that does not strictly fall within the definition of active or passive income.
Conclusion
Personal finance is an area where every individual should be able to make well-informed decisions. A monthly credit to your account in the form of a salary is usually the first experience a person has of an income. As the person gathers more experience, they become aware of other sources of income opportunities that they can tap. This is where passive income comes into the picture and understanding the distinction between active and passive incomes becomes crucial in wealth-building activities. Active income is the income earned directly by an individual for performing certain services, such as a job, or offering a vocation as a trade, such as plumbing or carpentry. In most economies, this income forms the cornerstone of financial stability, as it drives savings, which in turn enable investments. Conversely, passive income is generated purely through investments, such as renting out a property you own or accruing interest on fixed deposits. Portfolio income can be seen as a combination of the two, integrating the active approach of direct participation in financial markets with passive returns on assets and other securities. By smartly balancing and diversifying active, passive, and portfolio income streams, individuals can develop a robust financial portfolio that can continuously grow and provide support during crises.
