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What Is Residual Income? Understanding How It Can Grow Wealth

Last updated: July 8, 2019
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People looking to make money and gain financial stability need to understand residual income. The personal finance term refers to any money left over after expenses and debts are covered. Residual income is the money that you are able to do what you want with — and that includes investing.

A great way to invest residual income is by doing your best to create passive income streams — these are ways to gain income without putting in active work.

In this article, we’ll dive into residual income and passive income, and explain how the two are sometimes confused. We’ll also offer up some passive income ideas and answer frequently asked questions.

What Is Residual Income?

Residual income is a personal finance term that refers to any money left over after you’ve covered your living expenses. Essentially, residual income is the part of your net income — or take home pay — that isn’t already earmarked for bills.

For people looking to grow wealth, creating residual income is essential in that it gives you capital, which you can then invest and, in theory, grow.

Calculating Residual Income

Residual income: overhead of a workspace, arms in a business suit point to charts and data

To calculate your residual income, you need to calculate your individualized operating income — basically, everything you spend, plus any debts you need to pay off. Subtract that from your income, and you’ve got what’s left over — the residual income. The basic formula is:

Net Income – (Expenses + Debts) = Residual Income

There is a second definition for residual income that’s an accounting term used to help businesses calculate net income. That definition is defined by Investopedia as “net income less a charge for the cost of capital. The charge is known as the equity charge and is calculated as the value of equity capital multiplied by the cost of equity or the required rate of return on equity.”

The accountants reading this will look at that and nod knowingly. For the average investor who thinks that last passage may as well have been in German, no worries — all you need to remember is that, in personal finance, residual income is calculated by subtracting expenses and debts from your income.

Passive Income vs. Residual Income

The terms “passive income” and “residual income” are sometimes used interchangeably, but they have slightly different meanings.

Passive income is money that’s generated in the background without you putting in active work. Residual income is money leftover after you’ve covered all debts and expenses.

Passive income can generate residual income. Likewise, residual income can give you the capital needed to create passive income streams.

Creating Passive Income

Passive income streams need an upfront investment. It’s an old cliche, but it’s true: It takes money to make money. Or rather, it takes an investment to make money. This investment can be made with money (stocks, real estate) or intellectual property (a book, an online course) but they all require you to put in something.

But a passive income stream is a source of income that will continue to bring in revenue long after the initial investment of capital or labor.

Ideas for generating passive income streams are sometimes referred to as “residual income ideas,” but again, that’s not quite correct.

9 Passive Income Ideas

We’ve covered passive income and residual income, so let’s get to some actual, real-world ideas for generating passive income — which can help you build that residual income. Many of these ideas require money at the start to get them off the ground, but there are ways listed below to generate passive income no matter the amount of money you have. Those “no capital” ways still typically involve an initial investment, but rather one of either intellectual property, hard work, or both.

1. Rental Property

As long as people need places to live, there will always be renters. In some markets, monthly rent from tenants can cover the mortgage of the home you purchase, allowing you to have a revenue neutral investment (you’re neither gaining nor losing money on it) while the property itself gains value.

A rental property can be as small as a spare room in your house — Airbnb lets people rent out spare rooms and generate income that way.

2. Real Estate Investing Clubs

You can partake in real estate investing without having enough up front cash to pay for multiple down payments on homes. Investing clubs like CrowdStreet allow you to work with a group to devise a real estate investment strategy and pool your money to make investments that allow you to see passive income returns.

3. Peer Lending

Similar to real estate investment clubs, websites like LendingClub and Fundrise allow groups of people to come together and invest in small businesses. Some of these startups offer a percentage of equity, while most offer a set return on the investment within a certain time period. If you have capital and love startup culture, you can generate returns through these groups.

4. Blogging

It seems weird, but bloggers are constantly putting out intellectual property that can then exist online and generate passive income. It’s easy to build a blog with sites like Wix or WordPress, and you can quickly start generating ad revenue through Google AdSense. Have an idea to sell things on your site? Shopify can quickly set you up with a secure e-commerce platform to sell to your readers.

Prefer video to writing? A YouTube Channel could allow you to generate ad revenue and build a community online. Once the video is posted and passes a certain threshold of views, you will automatically generate passive income moving forward.

5. Affiliate Marketing

Affiliate marketing is the practice of online shops offering a cut to websites that share links to their products.

If you have a web presence with a big following, you can create affiliate links to sites like Amazon, which will give you a percentage of any sale made. Once you’ve posted your links online, your work is done — you can sit back and wait for passive income to roll in.

6. A Savings Account

A savings account is certainly an old fashioned investment, but interest rates are the classic way to build passive income. You put money in, and your money grows. Plus with the magic of compounding interest, those small returns can become big returns.

7. The Stock Market

Residual income: stock analyses on a computer screen

Investing in the stock market is another old fashioned way to generate passive income, but it’s a good one. Whether you’re investing in Fortune 500 companies, bonds, or dividend stocks, if you’re smart, you can make money without active work.

The stock market can require a minimum investment to see any real rate of return, but if you have capital, it’s a tried and true way to generate passive income.

8. Online Courses

Building an online course and then posting it can generate passive income long into the future. Sites like Udemy allow users to build great online courses on any number of topics and then get paid whenever people choose your courses to learn from.

9. Cash Back Credit Cards

Cash back credit cards aren’t usually what people think of when they think of generating passive revenue streams, but they apply. You spend as you normally would, and cash comes back to you. That’s passive income.

Frequently Asked Questions

We’ve covered residual income, the difference between residual income and passive income, and some ways to generate passive income streams. Let’s get to some frequently asked questions.

1. Can I live full-time off residual income?

If you have enough passive income streams or inherited quite a deal of money, sure, you can live full-time off of residual income. But that’s extremely difficult for most people. Residual income for most people will act as a form of savings or disposable income.

2. What should I do to make the most money quickly?

If you’re eager for financial freedom, you’ll want to know how to generate a ton of money quickly using passive income. Unfortunately, the ability to make a lot really depends on how much you can invest and how reliable your regular income source is. But be patient: Investing takes time, but it’s the key to building long-term wealth and giving yourself financial freedom.

3. Is there an online calculator to figure out my residual income?

Any online personal budget calculator can help you figure out the money left over at the end of the month, place that against your debts and figure out your annual or monthly residual income. Quicken has a free online budget calculator that we like.

Generating Residual Income

The key to building wealth is to generate as much residual income as possible and then invest that residual income to grow it. Passive income streams can help you in both regards — it can help you at first to create residual income and then smartly grow that residual income without making you work too much. Understanding these concepts and taking advantage of them can be the key to long term financial stability.

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