Passive income is making money while exerting the minimum effort doing it. Active income is where you earn income in exchange for your time and participation. Having passive income can bolster your active income over time, and eventually help you achieve your financial goals faster, such as retirement.
One of the most common ways people make passive income is through interest on your investment or savings accounts. And it can even be done in a tax efficient way where the passive income you earn is sheltered in a place such as an RRSP or TFSA in Canada.
But there are other ways to create passive income as well. Let’s examine some of the common ways to generate passive income, the benefits and downsides of this type of income, and what separates it from active income.
Key Takeaways
- After the initial set up, passive income is money earned through minimal effort, such as returns on investments, rental property income, and more.
- Active income is what you earn through employment where you perform a service in exchange for a paycheque.
- Both types of income provide value when creating a balanced financial plan.
Passive income vs. active income
Passive income is anything that earns value without having to exert much effort or work. Simply stated, little to no work = passive income.
The flip side of passive income is active income, which is what we traditionally think of as "the day job." This type of work is trading your time for money.
Here's a chart that compares the 2 sources of income.
| Passive income | Active income |
|---|---|
| * Income streams where you don’t have to actively work to earn money * Includes dividends on investments, rental property income, royalties or income from creative work, or peer to peer lending * Takes little time to upkeep * Creates a compounding effect * Money creates time (not really but it feels that way) * Usually can't entirely depend on it to survive * Often requires a big initial time commitment * There’s no one but yourself | * Putting in time and effort in exchange for income * Includes a job or side gig * Your main source of income * Immediate gratification * Competitive edge to do better work * Takes up a lot of your time * Hard to find inspiration |
As with anything, there’s a balance in having both passive and active income streams that should be considered in your working life. They can be complementary and help build your financial goals faster.
For example, those who value time over money may look for ways to create passive income and break away from the daily grind.
4 examples of passive income
So how can you start earning some passive income? Here are 4 common examples.
1. Return earned on investments
One of the most common examples of passive income, as stated earlier, is dividends earnings on investments held in either tax sheltered accounts (like RRSPs or TFSAs) or within a non-registered account.
Many investors choose an investment portfolio with dividend-earning stocks, ETFs, or mutual funds with the notion that once these dividends begin generating enough income to cover the cost of living, that person is considered to be retired.
But it’s no easy task when starting from $0.
Many people who choose a dividend approach to investing with the goal of passive income do so through robo advisors. Here are a couple of examples you could try out.
| Robo advisor | Fees | Average MER |
|---|---|---|
| Wealthsimple managed investing | * Under $100k: 0.5% management fee * Over $100k: 0.4% management fee | 0.2% |
| Questwealth | * Under $100k: 0.25% * Over $100k: 0.2% | 0.17% - 0.22% |
And, for the DIY investor, you may want to consider an online broker for a self-investment approach. Our top choice is Questrade, with its low-fees, variety of investment options, and ability to buy ETFs for free.
Check it out here:
Questrade is one of Canada's top online investment platforms. With very low fees, including no-fee ETF trading, commission-free stock trades, and plenty of investment types, Questrade just about covers it all.
- Total transparency with fees
- Surprisingly low fees
- Lots of investment account and product choices
- Plenty of convenient methods for support
- Limited amount of time to report fraud for full reimbursement
$25 GeniusCash + $50 bonus for funding a new account, and $0 commissions on stocks & ETFs- Excellent array of investing and trading tools
- Trade ETFs for $0
- Commission-free stock trades
- TFSA
- RRSP
- Spousal RRSP
- LIRA
- Locked-In RRSP
- RIF
- LIF
- RESP
- Family RESP
- Corporate
- Investment Club
- Partnership
- Sole Propietorship
- Individual Informal Trust
- Joint Informal Trust
- Formal Trust
- Individual Margin
- Joint Margin
- Individual Forex & CFDs
- Joint Forex & CFDs
- FHSA
- Stocks
- ETFs
- Options
- FX
- IPOs
- CFDs
- Mutual Funds
- Bonds
- GICs
- International Equities
- Precious Metals
$25 GeniusCash + $50 bonus for funding a new account, and $0 commissions on stocks & ETFs2. Rental income
Another way to generate passive income is by having a rental housing unit to rent out either monthly or on a daily basis through something like AirBnB.
I call this passive income as long as you find the right people to rent from you or manage the bookings for your day-to-day rental. But if you don’t have the best renters, this passive way of making money can become a very active way of making money. Meaning it will take a lot of time and effort.
That said, when rentals are good it can create a steady stream of money and be an excellent way to create a passive stream of income.
3. Sell your talents
Being a creative person can pay dividends. Whether it’s visual art, music, or writing, your talents can go a long way.
Speaking from personal experience, it can take a big leap of faith and countless hours to create something meaningful people can connect with. But when it works, it can really work out well.
The #1 rule for creating this type of passive income is authenticity and creating what you truly know.
I personally know people who upload 4K and HD content to various stock video footage websites and create passive income from people purchasing their footage in order to use it in everything from television shows to movies.
And I even got my documentary series The Illegal Eater streaming right now on Amazon Prime. The fact is, if you want to do something, it’s possible.
4. Peer to peer lending
This is something that has been happening in the USA much more than in Canada, but I can see it taking off in a big way in the Great White North.
Peer to peer lending is exactly what it sounds like and it’s available through such places as Funding Circle and Lending Club.
The idea behind it is to lend out extra money you have and create a passive stream of cash off of the interest payments. This is similar to what a bank does with their clients – but with higher rates than high interest savings accounts.
The only drawback is that the minimum investment in these programs can be steep and inaccessible to some (if not most) people.
Also, of course, there’s risk involved in lending to people who choose not to go through a traditional bank. Whatever their reason, you may or may not be comfortable with putting your hard earned cash on the line like this.
3 pros of passive income
So what are the benefits of earning passive income?
1. Takes little time to upkeep
The best passive income should take a very minimal amount of time for upkeep.
When it comes to investments creating passive income, checking on how your portfolio is doing on a quarterly basis means you’re likely spending less than 10 hours a year truly thinking about the passive income you’re creating for yourself.
When it comes to rental properties, 10 hours per week is certainly not out of the question for the amount of work needed in order to keep that income rolling in. But considering most people work an average of 40 hours per week, 10 sounds pretty darn good to me.
2. Creates a compounding effect
Having passive income in the short term is really beneficial, but when you see that money coming in over a long event horizon, say 10 years, it’s astounding to see how much wealth can be created for very little work.
A lot like the dividend investing approach, it takes a big sum of money to make more money. Well over the long term, the nest egg you’re building for yourself means your ultimate freedom to do what you want in life.
3. Money creates time (it doesn’t actually, but it frees up your time)
We all have limited time on our hands as science hasn’t solved the aging problem just yet.
Some of the ways to create passive income can be time consuming in the short term – here I’m thinking creative pursuits like writing an eBook or digital videography – but once the work is created, it lives on a platform ready to be purchased and make you cash.
In the big picture, you should have more time on your hands to do the things you want to do in life.
3 cons of passive income
Unfortunately, passive income usually isn’t the sole answer to all your problems.
1. Usually can’t entirely depend on it to survive
At the start, it can be tough to see the forest through the trees (to use a popular metaphor).
But just like anything else, finding that passive income stream and what your expectations for it in the short term are what’s important here
If you plan to quit your day job in the early days of you dabbling into passive income streams…it would likely be a mistake.
In fact, for most people, it takes many years of time and energy before they feel like they can pull back on the 9 to 5 day job.
2. Often requires a big initial time commitment
It takes time to get the ball rolling, so the initial time commitment can seem daunting.
Especially when creating a blog, eBook, or anything that may require minimal money up front for start up but maximum time.
Sweat equity is important to track and respect when it comes to your workload.
3. There’s no one but yourself
You have to be your biggest cheerleader when it comes to planning how to create these passive income streams. Most people truly understand the concept but don’t understand the journey you’re on.
Be your own biggest fan of your work. You don’t have to tell the world about what you’re doing just yet, but do celebrate the small milestones you reach along the way.
2 examples of active income
So what are some examples of active income?
1. A salary
This is the traditional job that takes up most of your time in the day.
Whether you work for yourself or a multinational company, there’s an expectation to put in the time in order to receive a salary.
The easy way always seems to be working for someone else, but many today have single-purpose companies that they earn income through.
2. A side hustle
Any type of work that isn’t your steady job is considered a side hustle.
This can be anything from being an Uber driver, to running deliveries for food companies, to teaching piano on the side to earn extra cash.
I once had a neighbour set up a barber chair in the front room of his house, taking clients at night when he had downtime from his 9 to 5 job. He had a steady stream of clients too, so he must have been doing pretty well for himself.
3 pros of active income
So what is there to like about earning active income?
1. Your main source of income
Active income for most people makes up their main source of income.
Think of it as your golden goose. It just takes a lot of effort for the goose to lay those golden eggs sometimes.
But having a main source of income means security and the confidence to start making bigger decisions in your life today.
2. Immediate gratification
There’s that feeling of trading your time for money that feels tangible, you can calculate it on the back of a napkin and figure out how much time you need to work in order to make X dollars.
There’s a motivation to that, a competitive drive that can help you feel the value in it.
3. Competitive edge to do better
Because you’re in an active work environment, some people use that competitive edge to create better work.
I know it rings true to me when I know I have 2 or 3 other people competing for the same job. That drive is what keeps me ticking and it’s likely the same for you as well.
I’ve heard far too many stories about people who retire and die 6 months later. What was keeping them alive all those years before? That healthy competitive drive to do good work.
$75 GeniusCash + Unlimited transactions for $0 + Ding-free non-affiliated ATM usage.
$25 GeniusCash + $50 bonus for funding a new account, and $0 commissions on stocks & ETFs
$12 GeniusCash + Access trusted news coverage 24/7 + Digital and home subscription options.
$25 GeniusCash + Delicious meal choices with fresh ingredients + Front-door delivery.2 cons of active income
Or course there are cons to active income creation and here are a few of the big ones to me….
1. Takes up a lot of your time
We all have limited time and to take up that time with work that may not be inspiring can be frustrating for most people.
You can’t create more time, so know you’re sacrificing one for the other.
2. Hard to find inspiration in working for someone else
You can hit a wall when working for others and it’s not inspiring. I think many of us have been in that type of situation and it can be intolerable.
In fact it can make you impulsive and put your active income into peril…by quitting.
Find inspiration in the little details and then think of ways to create passive income, since ultimately you’ll need both to survive. But a passive income stream may help you make better, clearer choices with your day job.
Do you earn passive income?
Are you thinking about creating a reliable source of passive income?
Do you hope that your passive income will one day be able to cover your expenses, instead of just being supplementary to your active income?
Let us know in the comments below.
FAQ
What’s passive income?
At its purest form, passive income is earning money while exerting the minimum effort. Passive income can be made through dividend investing, peer to peer lending, creative pursuits, or real estate to name a few.
What’s active income?
Active income is typically a 9 to 5 job or work where you trade your time for money. It can also include a side hustle, such as freelance work, working as a delivery driver, being a dog walker, etc.
Is passive income or active income better?
Passive income isn’t necessarily better but it frees up more of your time in order to do the things you want, when you want. It’s likely best to create a balanced scenario where you have both working in your favour, helping you reach your financial goals even faster than you imagined. Compare the pros and cons here.
Is there a best way to earn passive income?
However you choose to pursue earning passive income has to make sense to you. If you have a lot of extra cash on hand, then investing or real estate may be the best way to expend minimal energy for maximum income. If money is an issue, putting in extra hours and leaning on your creativity may be key to creating passive income. It’s entirely up to you!
How is passive income and active income taxed?
Ultimately the tax you pay depends on where your income is coming from and the tax rules associated with them. Typically you can tax shelter passive income by depositing it into a RRSP or TFSA, whereas with active income you have almost no choice but to pay a healthy amount of tax on it.
Leave a comment
Comments