Are you in business or working and earning an income? Does it bother you when you hear people talk about the various types of income and how you can make most of them? Not to worry, this is an area of confusion for many! A little search here and there is all we need to quench your curiosity.
Wealth creation requires research and understanding – this is the foundation of wellness. Most people are only familiar with what they earn and have little interest in breaking it down after the money hits the purse. This article breaks it down and shares some insights on different types of income.
Disposable Income
Disposable income is the amount of money left after all statutory deductions. For example, An employee in Kenya earns a gross income and pays; PAYE, NSSF and NHIF – statutory deductions. The amount that appears on their payslip as NET PAY is their disposable income. It is from the net pay where they pay for expenses such as; rent, food, school fees, healthcare, transportation, clothing and any other costs of their choice.
Discretionary income
Discretionary income is the money that remains after you have taken care of essential expenses. For example, if you earn KES100,000 per month after statutory deductions and spend KES50,000 on fixed bills, the balance of KES50,000 is your discretionary income. From this example, you have choices – you may choose to preserve and invest or spend the balance as pleases you.
Boundaries | where to draw the line
How you treat your discretionary income defines how our financial freedom journey unfolds – a quest that requires us to draw the boundary between our disposal and discretionary income. To achieve this, we ought to assign priorities to how we spend, save and invest – clarity emerges. Goal setting and continuous action shift us from relying on active income and introduces us to the world of passive and portfolio incomes. Now on to the three types:
(i) Active income (Earned income)
Active income refers to earnings from executing “hands-on” service. If you are in business or employed, the payments in terms of wage, salary or commission are your active income. That is, you have to be actively involved in person.
(ii) Passive income
These are earnings from; rental property or equipment, partnerships or enterprises where you are not actively involved. However, this does mean you would not put up any work! You must put in the effort way before you start enjoying the fruits! For example, building rental units require dedicated effort at inception. Consequently, once they are up and running, you do not have to break much sweat to receive a rental income.
(iii) Portfolio income
Stocks, shares and bonds investors earn dividends, interest or capital gains. These types of earnings are known as portfolio income. Buyers buy what’s referred to as paper assets. Thus, a buyer of shares gets a share certificate, while a land or property buyer gets a title deed.
Examples of investments that earn portfolio income:
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- Money Market Funds
- Government and Corporate Bonds
- NSE stocks
- Real Estate Investment Trusts (REITS)
- Exchange-Traded Funds (ETFs)
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Related reading income:
Spending Plan | 3 Tips on how to install freedom
How to stop the money headache
Personal Cash Flow | The importance?
Now that you have learnt about the different types of income, why not step it a notch higher by learning about cash flow? Cash flow is the catalyst of how we use our finances; it determines where we live (shelter), what we eat (food), how we dress (clothing), in addition to our other lifestyle needs. To overcome the challenges of settling bills, consider lowering your discretionary spending and increasing your income streams. A sure way is practising both approaches!
