How to Diversify With These 7 Streams of Income
Why have one income when you can have up to seven streams of income?
Contributing Writer at Tally
February 1, 2022
In today's fast-paced world, there are many ways to earn money. It doesn’t have to be getting a 9 to 5, working for 25 to 30 years there and retiring. Today, you have a wide range of streams of income to choose from.
These streams of income can help increase your cash flow and provide fallbacks in case something happens to your primary income stream. This diversification process can give you a sense of financial security to help you reach your financial goals.
Below, we cover:
The seven streams of income to consider
How difficult they are
How they work
The importance of diversification
What are the 7 streams of income?
When looking into potential income, there are seven types of income streams:
Capital gains income
Let's discuss these income streams, how they work and how difficult they are to establish.
Earned income is the most basic income stream that most people understand. It's the money you earn from working a full- or part-time job. This source of income is considered active income, as you must perform work to be paid. Once you stop working, the income stops flowing.
Earned income is one of the first income streams we experience, and it’s also one of the simplest streams of income to set up. You simply need to find a job, complete your work and collect a paycheck.
Profit income takes the leap from employee to a small business owner, as this is the income you make by selling items or services for more than they cost you. This can be as basic as a side hustle creating an item for $2 and reselling it for $5 on sites like Etsy or Amazon, but it can be as complex as opening a physical store.
This form of active income also includes the service industry. For example, if you're a self-employed freelancer, you want to sell your services for more than it costs you to deliver them. Or, if you're a rideshare driver, you aim to earn more for each trip than it costs you in fuel and wear-and-tear on your vehicle.
The profit income stream is slightly more difficult than earned income, as you must find an in-demand product or service — or manufacture the demand — and ramp up sales. This can take some time to establish, which is why many people slowly transition from earned income to profit income by working their business part-time after finishing their full-time job.
You can also hire a manager to run your business for you and only run the financial side when you're away from your full-time job. This increases overhead expenses, but it could also broaden your customer base and increase business income.
Interest income is money you earn from interest, just as its name implies. You can earn this by putting money into an interest-bearing account, such as a:
Individual retirement account (IRA)
This is a passive stream of income because once you deposit the money, the interest builds with no action from you. What's more, many of these accounts offer compound interest, so you can earn interest on top of interest, growing your income faster.
Building interest income isn't difficult, as it's simply a matter of depositing money and, in some cases, managing investments. However, it’s a long process, as it takes time to build a large enough balance to create significant interest income. This is why it's critical to begin this process early to build wealth.
When you invest in the stock market, there are two ways to build wealth:
Increases in stock prices
Earning dividends from any company you invest in
Stock prices reflect the stock's popularity, but dividends are tied to the company's performance. Dividends are payouts to shareholders based on the company's earnings. You get a higher dividend payment if a company has high earnings and turns a profit.
Because you do nothing more than purchase shares in a company to earn dividends, this is a passive income source that's relatively simple to start. However, like interest income, the amount you earn is relative to the amount of stock you own, so it can take a long time before you begin earning sustainable dividend income.
Remember, investing in stocks includes the risk of losing your entire investment. Consult with an investment professional before investing in the stock market.
Rental income is profit earned from renting property to a tenant. So, if you own a home with a $250-per-month tax bill and rent it for $2,000 per month, you have $1,750 per month in rental income, minus any maintenance or repair expenses.
Things get trickier when there's a mortgage involved, as you can't deduct any principal mortgage payments from your taxable rental income, but you can deduct interest, taxes and insurance.
Rental income can be one of the most difficult passive income streams to set up, as it often requires significant upfront cash to buy the property. Many banks want at least a 15% down payment even if you plan to finance it. But experts recommend an even higher down payment of 20 to 25%.
Then, there's the issue of actually profiting off the property and developing sustainable income. If the home is paid off, your positive income stream is immediate. However, if there is a mortgage, you may find your cash flow negative when you factor in maintenance, taxes and the mortgage payment.
However, with property typically appreciating, you're still building wealth, despite any immediate negative cash flow.
Capital gains income
Capital gains income is any income you earn by selling an asset, such as a stock, land, home, business and more. So, if you purchase property for $150,000 and resell it a year later for $250,000, your capital gain is $100,000.
Capital gains income is an outlier, as it can be either a passive or active income stream. For example, if you were part owner of a business but didn't actively participate in it, it sold for a capital gain. This would be passive income. However, if you were a participant, it's an active income. That said, selling a rental property for capital gains is always passive, no matter your participation level.
Capital gains income, on a small level, can be relatively simple. You could buy a stock at $50, watch it increase to $60, and then sell it for a $10 capital gain. However, on a grander scale, capital gain takes significant cash and patience, making it one of the more difficult streams of income.
However, if you start with that $10 capital gain, then reinvest it to get a $20 capital gain and continue in that manner, you can eventually work your way into a sustainable income and financial freedom.
Royalty income (a type of residual income) is the final of the seven types of income streams. This is when you build or create something once that continuously provides you with income. For example, when a musician creates a song and receives money every time it's played on a streaming service or each time an album sells, this payment is royalty income.
This can also include setting up affiliate accounts online and creating marketing posts for the affiliate's product on a website or social media. Every time a reader buys that product through your link, you get royalty income from the affiliate.
Royalty income can be one of the most difficult passive streams of income to establish, as you must find something people are willing to pay for again and again to maintain a sustainable income stream. However, once you strike that gold, the returns are nearly effortless.
Why is income diversification important?
Diversification is a word you'll often hear in personal finance. Basically, it's saying don't put all your financial eggs in one basket — spread it around a little.
Income diversification is mixing several or all streams of income to create one larger, sustainable and consistent stream of income. When you have multiple streams of income, you protect yourself against one or several going south and significantly hurting your cash flow. Sure, you may lose some of your discretionary income in this case, but you’ll still have positive cash flow.
For example, if you have an even split between rental income, royalty income and earned income, and a tenant fails to pay rent one month, you still have your royalty and earned income to fall back on. If you rely solely on rental income, you're depending on your tenant paying you consistently.
Set yourself up for financial success with multiple streams of income
Whether it's a few or all seven types of income streams, having multiple streams of income will help you balance your cash flow in tough times and maximize it in good times. While it may seem like a long time to wait for some of these income streams to create sustainable cash flow, starting today will ensure you make the most of it.
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