Passive Income vs Residual Income and Why It Matters

Learning the difference between passive income vs residual income is an important distinction. One of these incomes has the ability to truly change your life, and the other one not so much.

And perhaps you’ve heard the terms “passive income” and “residual income” before, but you’re not quite sure what they mean. You’re not alone – these two terms are often used interchangeably, and even financial professionals can have trouble correctly defining them.

Let’s take a closer look at the two types of income and how they differ to help clear up the confusion.

What is Passive Income?

Passive income is money earned from any enterprise with little or no effort on your part. It is not directly related to the amount of time you spend working. But once established, it can provide a steady stream of income that can help you reach your financial goals.

There are many ways to create passive income, but some of the most common include stocks, bonds, mutual funds, and affiliate marketing. Other options include creating and selling information products like e-books or online courses. Click to learn some of the best ways to make passive income.

The main defining characteristic of passive income is that the income stream does not require actively working. The income flows whether you work on it or not. You might have to oversee the income stream, but you are not trading time for money like a “job.”

What is Residual Income?

Residual income can be a form of passive income because you can earn it without actively working for it. But it’s not always the same thing. Depending on who you ask, whether a corporate finance manager, personal finance executive, or equity valuation professional, it may have a different meaning.

How Some Experts Define Residual Income

Corporate Finance Manager. A corporate finance manager would define residual income as any profits remaining after paying all company’s capital costs. It’s generally used to assess business unit performance or capital investment. It’s also known as profit exceeding the required rate of return or the company’s net operating income.

Personal Finance Executive. A personal finance executive defines residual income as the portion of your take-home pay left over after you’ve paid all your expenses, including debt. It’s also called “disposable income.” It’s often used to measure an individual’s financial stability or creditworthiness.

Equity Valuation Professional. An equity valuation professional would define residual income as the net income gained more than the minimum rate of return required to cover the costs associated with equity financing.

It’s also the valuation method and an economic earning stream used in determining the value of stocks. The model values an organization as the sum of the present value of its future residual income and the book value.

Basically, the definition of residual income depends on the circumstances of a company or an individual. For this reason, the two terms are not interchangeable, although both refer to money earned with little to no effort.

Benefits of Passive Income

Here are some of the benefits of passive income:

• Provide early retirement opportunity as long as you can live within the dollar amount provided by the passive income
• Does not require your full-time focus to generate and maintain the income
• Increased wealth
• Provides income security just in case you outlive your retirement funds, and can supplement these funds
• Offers protection against the loss of a partner’s income

5 Differences Between Passive Income vs. Residual Income

Purpose of the Income

While both incomes share a common purpose of boosting earnings, companies and individuals have different reasons for pursuing each type. For businesses, generating either is typically to gain more profits and pay more dividends to shareholders. For individuals, the motive is often to achieve financial independence and security and to create an emergency fund.

And most importantly, with passive income the goal is to create an income stream that does not require your primary focus. So a side hustle that can run partially on auto-pilot is a great passive income.

Source of the Income Stream

The source of residual income is generally related to the primary business or individual’s activity (think royalties). 

On the other hand, passive income can come from various sources, such as investments, real estate rental, or affiliate marketing through a website.

This is biggest the biggest difference between residual income and passive income. Residual income requires having some type of existing asset:

• Royalties from some established source
• Substantial investments to provide meaningful interest income or dividend payments
• Real estate this is owned and provides an income stream

With passive income through affiliate marketing, for example, you can create the asset with very little cash outlay. This is a very big (and important) difference, and the reason that this form of passive income is much more achievable for most people.

Participation

Residual income generally requires regular participation from the primary earner, while passive income doesn’t. That’s because residual income often comes from things like royalties, which require very little work on the part of the recipient.

On the other hand, passive income streams often come from hands-off investments, such as real estate rental or stocks. Or even better, building a website that can generate passive income over time. You can read our review here for one such platform that can help you build an income stream through affiliate marketing.

Viability

Residual income is often more viable in the short-term than passive income, but both have the potential to be long-term sources of revenue. Passive income can be challenging since it requires skill, time, and money before it pays off. It requires a lot of time to build, but once it’s built, the payoff can be amazing.

Risk

There is more risk associated with passive income since it’s often generated through investments. However, it varies depending on the source. On the other hand, residual income has fewer risks.

Final Thoughts on Passive vs Residual

Residual income and passive income are two different money concepts. Although both are types of income that don’t require much work to generate, they differ in their source, viability, and risk. 

Depending on your goal, either could be a good option for you. Residual income requires some type of asset or royalty to create the income stream, which is a tall order for most people.

For the average person without a huge bankroll to invest, passive income through affiliate marketing is a fabulous opportunity. You can get into this endeavor for reasonably low cost, and the upside is huge if you are willing to work and put in the time.

And it works for retirees as well as college students!

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