Why The Rich Get Richer, The Poor Get Poorer & The Middle Class is in Debt & Stressed Out: Part II – Active & Passive Incomes

RecessionMy story’s not a pretty one, but life ain’t always about “pretty.” Sometimes you’re the horse, sometimes you’re the shoe, but in the end, you actually step on each other.

I had been successfully self-employed since 1985 until the proverbial walls came crashing down in 2008. I was sitting there minding my own business when an unforeseeable force punched my equity and employment right in the gut. They went down for the count and never got up for another round. I had to throw in the towel.

Don’t get me wrong. I’ve been through hard economic times before and survived, like in 1989 when the bottom of the housing sector plummeted like a cartoon piano from the 10th-story, but this time I thought to myself, “When they take away employment too, they take away your dreams… they take your soul.”

I could choose to blame the bank, my loan agent, “Dubble-Ya,” terrorists, or even my former neighbor, George, who used to use my faucet to water his shrubs, but all it really was… was life. Life’s not supposed to be easy, it’s not supposed to be cruel; it’s just supposed to be. But like a game of hide-n-seek gone bad, life always finds you, whether you’re ready or not.

Eventually, my lucrative medical transcription business of 10-years closed its doors in 2010. That same year, a short-sale of my house followed, and I had to downsize and seek a new source of income. I had lost everything except a few personal belongings and a tapestry of debt. I had to begin to rebuild my dreams.

So, how do you avoid debilitating economic forces that are out of your control, pull yourself up by your bootstraps and take control of your financial future?

The answer is Income Producing Assets, of course! Remember? That’s what the wealthy buy on payday and the formula for acquiring  wealth (see my article – Part I: Why The Rich Get Richer, The Poor Get Poorer & The Middle Class is in Debt & Stressed Out).

But before I get into more than a dozen Income Producing Assets that you can easily acquire right now, let me first clarify 2 primary incomes and their 2 subsidiaries – Active Income (Proprietor Income) and Passive Income (Residual Income):

IncomeAct1. Active Income: Trading your time and labor for money in the normal course of working for another person or business entity or conducting your own traditional offline business of brick and mortar.

Most of the poor and middle class  fall into this category of earning because it’s ingrained in the majority through family (it’s what our parents and their parents did), through school (get an education and trade your time and knowledge for someone’s money), through culture (remember the 99%?) and other influential factors that I deliberately left out to simplify this article.

For example, a real estate agent earns a commission based on personal efforts, such as showing houses, staging open houses, seeking buyers and sellers, negotiating contracts, coordinating inspections and escrows; but if the agent stops her activities, her income will stop too.

17 Typical Active Income Sources:

  • Wages (hourly) & Salaries (monthly)
  • Tips (taxi, food server, valet)
  • Bonuses (Christmas, stock options)
  • Commissions (sales)
  • Annual Operating Income (The amount of profit realized from a business’s operations after taking out operating expenses – such as cost of goods sold or wages – and depreciation)
  • Stock Dividends (how much a company pays out each year relative to its share price; in the absence of any capital gains, the dividend yield is the return on investment for a stock)
  • Bond Interest (a debt investment in which you loan money to an entity – corporate or governmental – that borrows the funds for a defined period of time at a fixed interest rate)
  • Treasury Note Interest (a marketable U.S. government debt security with a fixed interest rate and a maturity between 1-10 years)
  • Annuity (a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date)
  • Capital Gains (An increase in the value of a capital asset – investment or real estate – that gives it a higher worth than the purchase price; the gain is not realized until the asset is sold)
  • Prizes (raffle, contest, competition, game show)
  • Awards (lottery, court settlement, gift certificate, scholarship, savings bond)
  • Rewards (lost & found, law enforcement info, bounty)
  • Alimony (spousal support)
  • Pensions (retirement, social security)
  • Royalties (intellectual property, inventions, software, books, music, T.V. syndication)
  • Gambling (winnings)

NOTE: Some income sources above may overlap with each other and/or appear to be passive income, like royalties, prizes, awards, and pensions. However, what’s considered passive income by my and your definition may be considered active income to the IRS. According to the IRS, all income sources above are considered non-passive in nature and may be treated differently by Uncle Sam.

IncomeActive2. Proprietor Income: Self-employment and owning your own business is a noble endeavor of many of the middle class and falls into the category of Active Income. I’m mentioning it separately because many people confuse this with Passive Income, because you’re not working for someone else and you’re the boss.

The problem with a fee for service approach to business, as with a general contractor or a lawyer, is your lack of knowing what your income will be next month or next year.

In a service oriented business you only have so many hours that you and your employees can work in a day. You can control how long you work, how hard you work, who you work with, who you network with, how you market and advertise, who your suppliers are, but not what your income will be month-to-month.

Monthly income is determined by your prices, ability to sell and negotiate, and ultimately what your customers are able and willing to pay on any given day, which is largely determined by the current economic outlook.

Due to so many outside influences on your business, you’re always at risk of losing your income entirely. Of course, you can always sell your business, customer database, equipment, inventory and goodwill, but you can’t sell your skillset or innate characteristics, such as ambition, positive attitude, good communicator, salesperson and negotiator that greatly contributed to your successful enterprise. Therefore, the actual value of your business is speculative and limited, and ultimately reduced to your equipment and inventory with your sweat-equity forgone.

IncomeResidual3. Passive Income: Generated by the wealthy via Income Producing Assets, this money is received on a regular basis, does not require your direct involvement and requires little effort to maintain it (like repeat customers who buy a highly-sought after consumable product month-after-month, who require very little of your time). This is a source of recurring income that you can reasonably predict each month, as well as an asset growing in value each month that is potentially transferable.

Most of us do not fall into this category of earning because it is not largely taught in public schools, nor passed down through family or instilled through culture. This income generating activity is generally considered to be in the top 1% and a fool-hardy risk, frowned upon by your family, friends, colleagues and neighbors.

Still, you should focus on building assets that produce streams of recurring  income that are predictable each month and that eventually don’t require your direct involvement. Even with Income Producing assets, there will always be things outside your control, but far less than the operating your own small business.

IncomePassive4. Residual Income: Passive Income can easily turn into Residual Income, which is revenue that occurs over-time from work done one-time.

  • An insurance agent who earns yearly commissions when customers renew their policies
  • A network marketer’s income from customers who reorder product every month
  • A guitar instructor who produces a video and sells it over the Internet or at the store where she teaches
  • A business consultant who creates and sells a social media e-book on the Internet
  • A photographer who provides photos to a stock photo clearinghouse and receives a royalty when a website visitor purchases one of his photos
  • A restaurant or retail owner who has acquired a long-term, trustworthy manager to operate the business without the owner being present

Always be on the lookout for income that doesn’t require your direct involvement, like Internet affiliate programs, eBook royalties or network marketing. If you want to earn more, work less, and have enough retirement, you must begin thinking about generating income streams that don’t require your direct participation.

Whether you’re contemplating starting a new business, or you’ve been operating one for a while now, the sooner you begin thinking about how to change your offline or online business into an Income Producing Asset that creates passive, residual income, the sooner you can achieve personal and financial freedom.

Please keep your eyes glued to your monitor for next week’s article, Part III: The Rich, Poor & Middle Class – 16 Income Producing Assets That You Can Acquire Right Now!

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