1. Earned Income
Earned income is the money that you make by doing something or spending your time, e.g. the money that you make in your job or salary you get by working for someone else.
Now this is where your quality of life will suffer the most because you will be trading your time for money.
In most cases, jobs will pay you just enough to stay over broke.
Quite obviously, JOB means Just Over Broke. The reason most people are not able to think beyond earning money through a job is that it offers a “relatively” comfortable zone.
Unfortunately, this comfort zone will become your biggest enemy and will keep you away from leading an extraordinary life. If you spend the maximum time of your life in this income stream, you will never have enough money to lead a truly wealthy life.
“Comfort is your biggest trap and coming out of comfort zone your biggest enemy.”~From the Rat Race to Financial Freedom
2. Profit Income
This comes from the money you earn by selling something for more than it costs you to make, e.g. businesses selling their goods at a profit, whether at the retail or wholesale level, as distributors or manufacturers.
You need to be an entrepreneur to earn profits.
The amount you need to invest depends on your goals, but you could start a small business with a small fund. However, this will take away a lot of your time, at least in the initial stages, until you learn to manage it really well and be able to make it churn on its own.
Entrepreneurship requires a different kind of mindset and risk taking capability.
Most of the people who are employed and are used to the earned income source want to move to this category at some stage of their career or life. But they find it difficult to make the move primarily because of the lack of guts to take additional risks. Most often, this lack of courage is justified with family constraints and needs.
To be an entrepreneur and start earning profits, you will need to identify a product or a service that you want to sell. Then you have to sell and manage your business well and maintain your clients.
For most people, earned income and profit income are the only viable means to earn serious money. They often tend to forget that there are five other equally viable streams of wealth generation.
3. Interest Income
Interest income is what you get from lending your money to someone else, e.g. putting it in the bank, lending it to the government in the form of buying treasury bills, etc.
This is a great source of passive income where your active involvement is not needed once the investment is made.
Many doubt the serious wealth it can generate, but when combined with the power of compounding and…
…the fact that this is a true passive income with the least amount of risk, it can beat any of the first two sources of income generation hands down.
An INR 3 crores lump sum can generate enough interest to feed you with a passive inflation-adjusted income of INR 1.5 lakhs per month and could last for 40-50 years with average family expenses in a metropolis city.
4. Dividend Income
This income is even better than interest income. It is equally passive and not only that, but it also makes you a shareholder of a company. This is the money you get as a return on investment from the company shares that you own.
It’s one of the best income stream, yet one of the most ignored and neglected.
If you invest smartly on ex-dividend dates of good blue chip companies, you can far exceed the returns from interest income since you are also a party to the capital gains the share price goes through.
This is one of the key financial instruments that we recommend for generating adequate cash flow because you can earn a very good income from it.
5. Rental Income
This is the money you get from renting out an asset that you own, like a house or building. It could bring you better revenues, but there are inherent drawbacks unlike the other four types of incomes.
One of the biggest drawbacks is the amount of money required to own a property before you could gain a regular rental income. Since properties are quite expensive, you may not be able to buy as many assets in your lifetime unless you have other sources of income.
For instance, you can easily start earning interest income or dividend income with a small investment of INR 1,000, but you can’t start a real estate business with such meager investment.
Another big drawback of this income source is the illiquidity of the asset. It is difficult to quickly liquefy this asset in times of need or when you move or re-balance your portfolio mix.
6. Capital Gains
This is the money you get from an increase in value of an asset that you own.
For example, when you buy shares at $10 and sell them at $11, the $1 is your capital gain.
Or if you buy your house for $200,000 and sell it for $220,000, the $20,000 is your capital gain. Keep in mind there are different tax laws in different countries for capital gains. However, there are ways to go around taxes as well.
7. Royalty Income
This is the money you get as a result of letting someone use your products, ideas or processes. They make all the revenues, they do all the hard work, and you get a small percentage of whatever they earn.
For example, if you have a Subway franchise, the royalty you pay Subway for using their processes, logo, marketing, etc. is royalty income for them. If you are a writer, you get paid for every copy of the book sold.
The biggest challenge here is to create something unique and then make it repeatable. You will need special skills to create such an asset, but once you do, there is virtually no limit to the amount of money you can earn.
Increase Your Cash Flow
These are the seven sources of income, and millionaires usually earn from two or more combinations. Most won’t have all of the seven. In fact, most of them won’t have more than one or two income streams.
For instance, Warren Buffet is a billionaire, but he doesn’t make most of his money from all seven of them. He became a millionaire first by using income stream four and six, which are capital gains and dividend income respectively.
He also didn’t get into capital gains for everything. Instead, he specialized on capital gains from companies in the stock market. Then, by constantly honing his skills in valuing companies and investing in them, he was able to become a millionaire, and then a billionaire.
Another example is Bill Gates, who became rich through both profit and royalty income streams. He founded a company, Microsoft, and an asset we know as Windows.
He used that to change the way we interacted with computers. He became so good in these two income streams that he became one of the richest people in the world.
There are umpteen examples of millionaires who came from using profit income, but they had to be really good at what they were doing. There are also a lot more millionaires who generate income from royalties.