Difference between Passive Income and Residual Income

difference-between-passive-income-and-residual-income

Many times Passive Income is referred to as Residual Income and vice versa. I personally think this is totally ok. As long as we all know what we are talking about we should not get lost in semantics.

Passive Income and Residual Income mean two different things though, and since I’ve been asked this question more than once I’ve decided to cover the differences here for those of you who really want to know what you are talking about.

Passive Income

Passive Income is what all financial freedom seekers are looking for. It’s what I’m looking for (and hopefully achieving one step at a time) and what I talk about 90% of the time on this blog.

You can read my full definition of Passive Income here, but to make a long story short Passive Income is “income that you receive on a regular basis generated by assets/work/projects you did in the past and that require little effort to maintain today”.

Example of Passive income can be rent you collect on a monthly basis from a real estate property you own, dividends you get paid from stocks you own, royalties you get paid for a song you wrote or a book you published years ago, etc. All of these required some initial work (earn the money to purchase a property or buy stocks, spend the time to write a song or publish a book, etc.) but you can basically forget about them once the initial “work” is done and they will still continue to generate revenue for you month after month.

Residual Income

Residual income on the other hand is something anyone with a healthy personal finance has. Residual Income is defined as “the amount of money you have left to spend each month (or payday) after covering all your expenses”.

This figure is what most banks and lending companies will look at in order to determinate whether you are capable of getting into more debt or not and therefore give you that credit you asked for or not. It’s also the number you should look at yourself before getting into something which will represent a recurring expense, like a gym subscription, a car lease, etc.

This would be a very simplified example: If you make $3K a month and pay $1K in rent, $300 in utilities, $250 for your car, $150 in gas and $600 in food, your Residual Income would be $700 per month. Now if you want to sign up for a $100 per month gym subscription that’s probably assumable, however if you want get into a $500 per month car lease you should be careful as your monthly Residual Income will be reduced a lot to the point where you might have trouble paying any unexpected expense unless you have a comfortable cushion of savings.

Easy, right?

Conclusion

Residual Income is something everyone has, and as long as it stays positive it means you are living within your possibilities. On the other hand, if your Residual Income is on the negatives this means you are getting into more debt every month and should seriously think about changing something in order to fix this.

Passive Income on the other hand is a sort of business model, one of which I’m passionate about (as well as many other people out there). You can decide whether you want to get into Passive Income or not, not everybody has to, although I do recommend everybody does to a certain degree. If you manage to get to the point where you Passive Income exceeds your expenses then you would have achieve financial freedom and will be free to do whatever it is with your time without having to worry (at least not too much) about work or money.

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