It is said that the average millionaire has 7 streams of income whilst the average person has 1. Having only one source of income, typically a job, can make you financially vulnerable. By diversifying your income streams you can minimise any financial risk.
#1: Earned income
An earned income is what you get from a job; this includes the average worker to the CEO. Earned income is when you exchange time for money. This is known as an active income. This can be whether you are employed by the government or a company or self-employed. An earned income can be a good starting point for building financial freedom but it can become dangerous if you do not expand from this category as you are leveraging your time for money and you have a limited amount of time. This is also one of the highest taxed forms of income and it can be taxed up to 40 percent.
#2: Profit income
A profit income is where you sell products or services for more than it costs to produce them. In the past it required sizeable investments to buy or make the products but it has become significantly easier in recent years with the invention of the internet. Whether you sell a physical or digital product, if you sell it for a higher price than it costs to manufacture it then you will make a profit income. A profit income can be active or passive depending on what type of business you have. If you are actively making the products you sell then it is an active income. If you have a manufacturer for your product or you can create it once and sell it multiple times it is a passive income. This is because your business no longer requires your presence to function and profit.
#3: Interest income
You make interest income by collecting interest on money you lent. You can lend money to banks in the form of a CD (Certificate of Deposit), or to companies on the form of a bond and to the government in the form of treasury bills. These are typically the safest way to invest your money but are not as lucrative as they have a 1-4% return rate, per year, on average. This is a passive form as income as your involvement is not needed.
#4: Dividend income
Dividend income is when you invest in stocks that pay part of their profits to their shareholders. When you buy a stock in a company you become a shareholder and when that company reports profit they will send money to all their shareholders, typically every quarter. Dividend income is taxed a lot less than earned income. In 2019/2020 if you earn from £0-£37,500 in earned income you pay 7.5% taxes on your dividend income. If you earn £37,001-£150,000 you pay 32.5% tax and it caps off at 38.1% tax if your earn more than £150,000.
#5: Rental income
Rental income normally comes from buying property and renting it out to other people. It does not necessarily have to be home rentals, you can also rent out commercial property to businesses. Rental income does not have to come from real estate and can be applied on a smaller scale. Many people rent out equipment, cars, instruments etc.
#6: Royalty income
This type of income is when you get paid after your work is done. Whether you worked in a movie that continues to be watched or wrote a book that continues to sell. Royalty income is money you make by letting other people use your ideas or property to make money. For example, if an author allows a publishing company to sell their books. Every time someone buys that book from the company the author gets a small commission.
#7: Capital gains income
Capital gains income is when an asset that has appreciated in value is sold. The most commonly traded assets are real estate and stocks. For example, if you bought 100 shares in a company for £10 a share and sold them for £100 a share. You would of made £9000 in capital gains. This is different from profit income as you are not selling a product you bought or made. Capital gains are one of the least taxed forms of income ranging from 15%-20% tax depending on the amount earned. You are also able to pay no tax, such as in real estate. If you reinvest your capital gains back into the market you could pay no taxes in many cases.