What Is Residual Income, and How Can You Build It?

Doing something once and getting paid for it for the rest of your life? It almost sounds too good to be true. That’s the general idea behind residual income.

Study up on the concept of residual income by learning a few definitions, understanding why you should care about residual income and finding out how to get started yourself. 

What is residual income?

Usually, giving a definition is a quick and easy task. However, in the case of residual income, it’s a little more complex. 

Depending on the context of the question and who you’re asking, you might get a few different answers.

Here are a few common definitions that can help you avoid any potential confusion.

Residual income as passive income

Residual income usually refers to money an individual receives without working directly for it. It’s not about getting paid for doing absolutely nothing, though. Usually, you have to invest money or time upfront and it offers a consistent income stream down the line.

You may have heard this phenomenon referred to as “passive income,” especially in the self-help and side hustle world. There’s no need to get confused, since the two terms can be used interchangeably — unless you’re going by one of the definitions below.

Residual income as disposable income

Residual income is sometimes used to describe the income an individual has left over after paying their expenses. For instance, how much of what you’re earning is available to use as you like after accounting for things like student loans and mortgage payments?

In this case, residual income is an excellent indicator of a borrower’s financial health and creditworthiness, especially since passive income sources can result in even more expenses (e.g., the costs of maintaining a website).

Residual income as net operating profit

Similar to how residual income can represent income after paying obligations for an individual, it can also reflect a company’s profit after the cost of capital. 

Just as disposable income helps determine the health of an individual’s finances, a measure of economic profit reveals how well a company is performing.

Residual income as equity valuation

Residual income is also one of the valuation methods that companies use to value their stocks. In this case, it’s a firm’s net profit minus capital costs. 

You can think of this as another way to measure profit, and it helps investors decide if the firm or venture is worth putting their money into.

So, which definition should you use?

For the rest of this article, we’ll refer to residual income as passive income. Not only does this happen to be the simplest definition to understand, but it’s arguably the concept that will have the most impact on your life.

Examples of residual income

Even when you limit yourself to one definition of residual income, there’s a fair amount of flexibility in the ways you can earn it. 

Here are a few examples — from financial to artistic and everything in between.

If you invest in the stock market and all goes well, you’ll start to earn on your assets — meaning you’ll make an upfront investment, then continue to earn money without having to do anything extra. 

This could take the form of dividend stocks (when companies regularly pay out money to shareholders) or simply the interest you earn from other investments, like funds or peer-to-peer lending.

Residual income can also be an alternative to the standard hourly, weekly or monthly wage you receive in return for your labor. For example, the actors from the sitcom Friends are estimated to earn around $20 million each per year in royalties (meaning they earn a share of the show’s profits). 

Workers in some professions may ask to be paid in royalties instead of a fixed salary, or ask for a lower fixed salary and higher royalties. This is sometimes feasible for freelancers in niches like social media management, graphic design or copywriting.

Bonus passive income ideas 

Even if you're not working in a sector where royalties are feasible and you’re unsure about becoming an investor, you can still set up a residual income stream. There are plenty of different side hustles and gigs out there. 

Here are a few residual income ideas that might suit your skillset:

• Affiliate marketing (e.g., promoting Amazon products through a blog)

• Content creation 

• Real estate investing, such as establishing a rental property or Airbnb

• A Shopify or other e-commerce store

• Selling stock photos 

Benefits of residual income 

When done right, residual income literally means you'll have more money coming into your bank account each month. Who wouldn't want that? 

Still, since so many people don't have a source of residual income, it's worth taking a moment to outline why establishing one is worthwhile.

Have a Plan B

Having one or more sources of residual income is kind of like giving yourself an insurance policy. 

The world is changing fast, and we can’t rely on having one job for life — a robot could take over your role in a few years or your skillset could become obsolete. 

Then, there are the more traditional worries like getting fired or being left unable to work due to illness. 

Knowing you’ll have some cash flow regardless of what happens can be a game-changer.

Set yourself up for a better financial future

What stops many people from saving enough for retirement, paying off their debt and setting up an emergency fund? Not having enough disposable income to do all of the above while still meeting their other financial obligations.

Residual income means more income overall and gives you a larger amount of money to play with each month. Just think how far that could take you and your finances.

Freedom and peace of mind

If you focus on the short term, you might think that having some extra income will allow you to pay off debt or purchase that new car you’ve been dreaming of.

That’s awesome, but, over the long run, there’s an even more powerful benefit: the peace of mind that comes with financial freedom. 

How amazing would it feel to know you could quit that job you hate because you have enough money to tide you over while you search for something else? 

What about being able to drop down to part-time hours to focus on a passion project?

Sometimes, you simply don’t realize how much your financial situation is holding you back until things can finally change.

Let’s get residual

Hopefully you’ve come to realize why setting up a passive income stream is a worthwhile venture, and maybe you already know which idea you’d like to kickstart. 

You might not be in a position to quit your 9-5 overnight, but, if you commit yourself to this path, you could consider reducing your hours in a few years’ time.

Residual income is closely linked to many other principles of personal finance, like money management and loan payments. If you’re wondering where else you can touch up your finances, consider signing up for Tally's† newsletter. We’ll send you regular tips, so you and your wallet can get exactly where you want to be.

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.