Residual income means the income that one continues to receive after the completion of the income-producing work with minimal activities to maintain that residual income.
In corporate finance, residual income can be used as a measure of corporate performance, whereby a company’s management team evaluates the income generated after paying all relevant costs of capital.
Why do You Need Residual Income?
You have probably heard the expression that “the rich get richer while the poor get poorer.” It’s often used to explain the unfairness when it comes to money.
However I don’t think this is unfair at all. The reason it happens is because the rich focus on a completely different way of earning money. There are thousands of stories about poor people who accumulated great riches and this choice is available to all of us.
Warren Buffett, Bill Gates, Richard Branson, and Oprah were not born into riches. Yet over their lifetimes they’ve amassed huge personal fortunes. This is because they understand and use the power of leverage through residual income like we’ll talk about today.
What is Active Income?
Active income comes as a direct result of our efforts. This is when we work for one hour and get paid a certain amount for that hours’ work. This can be seen in wages, salaries, and self-employed service providers like lawyers or doctors.
There are many people who get paid vast amounts of money to become the CEO of a company, play professional sports, or star in a movie. Earning a high active income is often a lot of hard work and requires a dedication beyond most of us. It’s also limited because no matter how much money you get paid you still need to show up to work to earn your money.
What is Residual Income?
Residual income is when you continue to get paid after the work is done. This includes royalties from books, movies, or songs and also income that comes from real estate or business investments where you don’t actually have to be present to earn it. For example, Bill Gates is still making a residual income from Microsoft even though he isn’t working there anymore.
Residual income comes from building an asset that continues to pay you after the work has been done. A book, movie or song is an asset to the people earning royalties from it. A house is an asset to the landlord being paid rent and a business is an asset to the business owner who does not need to be involved in the day-to-day activities anymore.
What is the Passive Income Myth?
Many people talk about passive income and create the impression that you never have to do anything to keep that income going. The truth is that you will normally have to keep your eye on things if you want it to run smoothly. For example, Richard Branson doesn’t run any of the 400+ companies he started but he goes over the numbers each day to make sure they’re performing well and calls the CEO if there are any problems.
There is also an idea that we should work to build a passive income asset and then sit on the beach relaxing for the rest of our lives. The truth is that most people would get extremely bored with this scenario and will be eager to find something to do. That’s why the world’s billionaires continue to work… they love what they do and it stopped being about the money a long time ago.