The 3 Types Of Income Every Investor Should Be Making

When talking about income, most of us when we were younger used to think that the only way to become wealthy was to get a high-paying job. 

Simple enough right? We just needed to work for an employer and receive a paycheck. The higher the paycheck, the faster one could get rich.

As time passes, you might learn that this type of income is known as earned income, and is not the only one that exists or the most effective way to build wealth. It just happens to be the income that you actively get by doing work for someone else.

In fact, there are many ways in which you can earn money throughout your lifetime, and these options are as varied as they come. from investments to Social Security, there are several ways to generate money

Of course, the ways available to make money will have to be aligned with your goals, so you can maximize their effectiveness. If you’re an aspiring investor you should focus on the three types of income that you can use to build wealth.

Let’s start with the one you probably know very well:

Earned Income

When you first start out on your financial journey, this is the only type of income that you’ll be able to earn. This is income that you receive in exchange for doing work for someone else, so basically, you will be trading your time for money.

We tend to think of this type of income as the only way to get ahead, and with good reason. You study a profession or master a craft and through hard work, you will either receive payment for your work immediately once you finish or you’ll have to wait a few weeks at most.

Here is where lies the main benefit of earned income: you can earn it much faster compared to the next two forms of income we’ll discuss. It sounds pretty good for many people, but that’s just because only a few are aware of the limitations, a couple of which are very clear:

1. You’ll always have to sacrifice your time for money. 

This means having to work for eight hours or more five days per week. Add the time spent commuting and potentially bringing your work home, because there’s always an email or text that needs to be answered.

And then, what happens if you lose or quit your job? Your income will dry up quickly. Even if you work or excel in a high-paying industry like medicine or law, if your only source of income is earned income, you’ll have no money coming in the door once you decide to take a break or stop working altogether.

2. Earned income has high tax rates relative to other forms of income. 

Earned income is taxed at ordinary rates, which are higher than capital gains rates. Compare the highest individual ordinary tax rate of 37% vs. 20% for the highest capital gains rate.  

Along with taxes, you’ll have to pay Medicare and Social Security, which means a decent chunk of the income you earn won’t actually land in your pockets.

To get an idea of how much can be deducted from your earned income, take a look at the tax rates for various income levels as of 2019:

 

Rate	For Unmarried Individuals, Taxable Income Over	For Married Individuals Filing Joint Returns, Taxable Income Over	For Heads of Households, Taxable Income Over
10%	$0	$0	$0
12%	$9,700	$19,400	$13,850
22%	$39,475	$78,950	$52,850
24%	$84,200	$168,400	$84,200
32%	$160,725	$321,450	$160,700
35%	$204,100	$408,200	$204,100
37%	$510,300	$612,350	$510,300

Source: Tax Foundation

Capital Gains Income

Also known as portfolio income, this is the one you earn from selling an investment for more than the amount you paid for it. 

The most classic example of capital gains income is selling a real asset or business interest. In the public markets, it can be derived from the sale of stock.  buying a stock for a certain price and selling it at a later date for a higher price.

For example, suppose you buy $1,000 worth of shares in a stock index fund that eventually appreciates at a price of $1,500. If you decide to sell those shares, you will have earned $500 in capital gains income. 

Whenever you sell an asset for more than the price you bought it at, you will receive capital gains income. Some other examples of assets you might sell include bonds, precious metals, and real estate of course!

In most cases, it doesn’t require active work for you to obtain capital gains, which makes this type of income mostly passive. 

Also, This type of income is taxed more favorably than earned income. When you earn capital gains income, you will have to pay capital gains taxes. However, these are lower than earned income taxes, since the amount of capital gains tax you’ll pay is dependent on your ordinary income as well as how long you held an asset before you sold it.

This makes it a great option for real estate since historically this industry has lived up to its potential for long-term appreciation. 

However, it is not without its drawbacks.  It requires you to have existing capital to invest in those same assets that have the potential to appreciate. As opposed to earned income, it takes much more time and care to start accumulating capital gains.

Passive Income

Here’s where we like to put all our chips. With passive income, you don’t have to sacrifice your time to earn it. Instead, the assets that you own are able to produce income for you while you dedicate your precious time to something else.

There are several ways to set up a stream of passive income, and investing in multifamily and assisted living projects is just our favorite. Once you start renting properties and maintaining your investments, you can have a new source of cash flow where minimum effort is required on your part (once it is properly set up).

With passive income, not only can you be generating multiple streams of income, but you’ll be able to keep more of it as well since income derived from passive sources held for more than a year will be taxed at capital gains rates instead of higher ordinary rates.

What can I do to have more than one source of income?

Everyone needs to start somewhere, and most people are dependent on earned income when they’re first starting their own journey to build wealth. 

But to gain freedom from this dependence (and ultimately financial freedom), you need to acquire assets that can produce either capital gains or the much desired passive income.

First work for money. Working overtime and climbing the corporate ladder should only be mere means to an end – to accumulate more capital to invest in passive income sources. This will put you on the road to financial independence.

Then, once your earnings exceed your expenses, make your money work for you. Here’s where you start the transition to start generating true wealth and eventually retire with the certainty that you have built an enduring legacy for your loved ones.

If you’re ready to start your journey and achieve financial freedom and independence, you can always reach out to us! We like to have FREE consultation calls with anyone who is interested in generating more cash flow.

Don’t hesitate to schedule a 15-minute call and we’ll be happy to help you with everything related to investing passively in real estate!