Sources of income can be categorized into three broad types: active (earned) income, passive income, and portfolio income. Any money you ever make (other than maybe winning the lottery or receiving an inheritance) will fall into one of these income categories. To understand how to become rich and create wealth, it’s vital to understand the interplay between these three sources of income.
What is Earned Income?
Earned income (sometimes called active income) is the linear income you earn through working. Essentially, you trade your time and skills for money, and there is usually a direct correlation between the amount of time and the money earned.
This type of income is usually limited by your time and skills. Therefore, trying to earn wealth is an arduous, inefficient way of generating wealth. You can only work so many hours and add so much value by yourself that your earnings will ultimately be capped at a certain level. When it comes to earning your income, you’re the golden goose. If you were to rely exclusively on yourself to generate wealth, the golden goose would eventually cease to produce revenue due to overwork or perhaps even ill health. It’s important also to remember that as you age, your physical or mental capacity will reduce. So, you will soon have to start supplanting your active income with passive and portfolio income.
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Time and Tax – 2 Limiting Factors in Wealth Creation
There are two main shortcomings of earned income:
Time – or more specifically said ‘Your Time.’ Earned income requires you to trade your time for money. Time is a limiting factor, i.e.the amount of time you are willing or able to invest. As soon as you stop working, you stop making money. No matter what, there are only 24 hrs in the day, and you can only reasonably expect to work 8 of those on average over the long term.
Tax – This income is the most heavily taxed form of payment, plus the more you earn, the more tax you pay. Personal tax rates in the US range from 10% to 35%. However, it is also subject to other taxes as well, such as social security (12.4% (half paid by the employer) and Medicare taxes (1.45%). Therefore, if you are a relatively high earner, your income could be taxed at a true rate of almost 50%! Ouch…that hurts!
One huge benefit of earned income over the other income types is that you generally don’t need any startup capital to start making earned income. Hence, most people rely on earned income from the start of their working life.
Can You Become Wealthy from Earned Income?
Most people work for earned income…most people aren’t wealthy. Regardless of your definition of wealth, you will never be truly rich if you rely exclusively on monthly earned income. You can end up in an endless cycle of earning income and paying bills. That said, used correctly, earned income can be a good way to start your investing and wealth creation endeavors, so long as you save 10% of your income intending to accumulate a lump sum of cash. This lump sum (i.e., capital) can generate the other two types of income. In addition to saving a percentage of your earned income, you could also reduce your debts by allocating part of your earned income to accelerate the reduction of personal debt, eroding your wealth.
Building wealth and achieving success shouldn’t be about extracting every last ounce of your energy and resources to get there, for that carries a huge personal cost and can sometimes prevent you from sustaining this success. If you’re serious about wealth creation and learning how to become rich, you must make the leap from relying on active income and start generating passive and portfolio income as soon as possible. You can learn more about passive and portfolio income in other articles and blog posts on www.MillionaireMindsetSecrets.com.
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