There are three types of income:

  • Active (or earned)
  • Portfolio
  • Passive

Active (or earned)

Active income is the money for which you actively work by trading your time for money. You do work and you get paid. Earned income is the most common way of making money. Examples include working as:

  • an hourly employee;
  • a salaried employee;
  • a contractor or freelancer;
  • a consultant;
  • a babysitter, lawn mower, etc.;
  • a business owner.

Portfolio

Portfolio income is money you receive from investments (stocks, bonds, property), dividends, interest, and capital gains. Portfolio incomes can come from three primary sources:

  • Interest - cash paid out, usually at a fixed rate, by bonds, bank savings, checking and money market accounts, or certificates of deposit.
  • Dividends - money paid from company profits to shareholders of the company’s stock
  • Capital Gains - the profit from selling an investment at a price higher than the amount paid to buy the investment.

Passive

Passive income is earnings from a rental property, limited partnership, or other business in which a person is not actively involved. Examples include:

  • Royalties from online book sales
  • Renting or leasing equipment
  • Renting properties
  • Affiliate marketing



Your Income Stream

The income you have received is typically in your checking account. This is the money that you have available for use today.

You also have money that you have not been paid yet. This is the income that you expect to receive from working at one or more jobs.

Each time you receive a paycheck and deposit the money into your checking account, you convert your expected income into received income.

Viewed together, your expected income, deposits, and received income make up your income stream. The three different parts of your income stream are each important for managing your money.

Expected Income

What you expect to receive is the money that you want to budget for future spending and saving. When accurately forecast over the coming months, expected income becomes the basis for your detailed monthly spending and saving plan.

Received Income

The income that you have received is the money in your checking account that you use for spending, paying bills, making credit card payments, and have set aside for your sinking funds and savings.

Deposits

While they may seem trivial, how you deposit the income you receive is a key part of your income stream. Your future spending and saving plan will work only if the amount of each deposit is never less than the expected amount. A deposit can be more than an expected amount, but never less.

Getting back cash when you deposit a check is a habit that is best avoided. As you will see in the “Your Choices – Spending” topic below, controlling the cash that you spend is critical to effectively managing your income. The recommended way to avoid the cash back habit is to have your checks directly deposited. When you sign up for direct deposit, your money is electronically sent to your checking account on payday. You do nothing other than record the deposit. This is a trusted technology that is dependable, quick, and very convenient.

Having your paychecks directly deposited means one less thing you have to do.



Types of Income Streams

There are two types of income streams identified by when the income is expected.

Predictable Income Stream

The expected income in a predictable income stream is received on a known schedule. Each expected amount is fairly consistent. Examples include:

  • Hourly and salaried employment
  • Interest
  • Renting properties

Unpredictable Income Stream

The expected income for an unpredictable income stream has an unknown schedule and/or an amount that is sporadic. Examples include:

  • Being a contractor or freelancer
  • Working as a consultant
  • Babysitting, mowing lawns
  • Owning a business
  • Renting or leasing equipment
  • Dividends
  • Capital gains
  • Royalties from online book sales
  • Affiliate marketing



Income Streams Can Be Chaotic

It seems logical to plan your spending and saving based on when you get paid; after all, that’s when you get more money. Normally, however, this intuitive approach to managing your money doesn’t work well.

To start with, people often think of paychecks and paydays as the same thing. They are not. Misunderstanding the difference between paychecks and paydays can add further confusion to the chaos. Very simply:

  • a paycheck is income, and
  • payday is when a paycheck is received.

A paycheck is money that you deposit into your checking account and then record the deposit. A payday is an event that has no value. Recognizing this distinction between a paycheck and a payday opens the door, as we will see later, to stopping living paycheck to paycheck.

Paydays Just Happen

There is no standard schedule for when employers will pay their employees. Paydays are scheduled for the benefit of the employer with no concern for how employees will be affected financially. This can make planning your spending and saving based on paydays difficult.

Getting paid with no plan for what to do with the money often leads to financial trouble because of what typically happens each payday. Many people:

  1. Get paid.
  2. Pay bills.
  3. Make a payment on credit cards.
  4. Use what’s left for spending money.
  5. Use credit cards when spending money runs low.

This is living from paycheck to paycheck. It is a downward financial spiral that normally leads to growing debt and the stress that goes along with having little or no control over your income.

Living payday to payday can be especially chaotic trying to manage finances based on paydays when a household has multiple income streams. Having more paydays can mean either a shorter time between paydays, or larger paydays. Regardless, more income often results in more money being spent on more expensive items. The result is the same except the amount of debt is larger. The stress is stronger.

Calm vs. Chaos

Planning your spending and saving from payday to payday seems intuitive, but is wrong. Instead, basing your plan on when you need your money to pay your bills each month provides a sensible basis for budgeting that is consistent and can be used by everyone regardless of when they get paid.

When you are planning your money based on when you pay your bills, what happens on paydays? As you will see in Chapter 3, not much.



Managed vs. Unmanaged Income Streams

When you have more than one income stream, you may not need all of your income for day-to-day spending and saving. You may not want to include what may be considered extra income in your day-to-day planning.

For example, two people in a household each have a full-time job. They also receive a quarterly payment from a grandparent’s endowment. They choose to deposit their paychecks into their managed checking account. They deposit the endowment checks into an investment account that they don’t touch except for emergencies.

The difference between a managed and unmanaged income stream is simply where you deposit the checks: into the checking account that you manage, or into any other account.

Managed Income

A managed income is included in your future spending and saving plan. All income checks are deposited in full into the managed checking account.

Unmanaged Income

An unmanaged income is not included in your everyday spending and saving plan. No checks from an unmanaged income are deposited into the managed checking account.







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