Passive and active income
Published 05/05/2022 | Last updated on May 05, 2022
To be able to save effectively, you must have assets. And more importantly, you have to know how to distinguish them from liabilities. From the confusion between assets and liabilities derive many of the problems that affect the personal finances of entrepreneurs.
The wrong preconceptions about certain elements often cause this confusion. For example: Are houses a liability or an asset? Is employment an asset? Is keeping money in banks better than investing it?
Read on to find out the answers to these questions and learn what liabilities are, what assets are, and how to improve your personal finances.
Having an income and a stable income is necessary to be able to live and to be able to offer a certain quality of life for oneself and for the other members of one's family. As a consequence, in many cases, it is necessary to exchange time for money. However, not all income comes in the form of a pay letter or bank transfer. Rather, some income comes from investments that have been made and do not require your active effort to obtain. It will be very useful for you to know the difference between passive and active income.
What is a financial asset?
We can define a financial asset as all those assets, properties, and tools of a person that can be converted into money.
It is a form of saving that does not imply saving money, but converting it into instruments that safeguard its value and protect it from inflation, in order to obtain better benefits in the future.
They are usually divided into three types:
1. Fixed Assets are those assets acquired with the intention of not selling them in the short term, but using them; for example a company's machinery, our vehicles, and homes, among others.
2. Current Assets, on the other hand, are those short-term circulation instruments that, nevertheless, serve us to generate income or protect the money we have. This is the case with our savings accounts or some extra work we take on to earn additional money. However, the assets that really serve to save money are financial assets.
3. Financial Assets are those assets and instruments designed and acquired with the intention of obtaining a future income higher than the one originally invested. They are a means to generate wealth, save effectively, and convert the expenditure of our money into a way to multiply it.
Read on because below, we will show you how to identify whether you have assets or liabilities and what type of assets you own.
This kind of income is the one that you get when you make an activity, and you receive profit from it. Among active income, we can find payments, salaries, or tips. Usually, you have to dedicate your time and work in a complete way to get it.
For example, if you work in a company, you will receive a monthly salary for performing certain activities during a previously agreed-upon work schedule. If you are in sales, you get a commission for each product sold, in addition to a salary.
But if you stop performing that activity, miss work, or do not make any sales, then you will not receive any income.
According to Investopedia, a portal dedicated to investment education, the main advantages of active income are:
- That it is a low-risk form of income
- The inflow of income is much more predictable (it is usually biweekly or monthly).
- It allows the planning of a monthly budget.
But it also has some disadvantages to consider:
- People become risk-averse, to generate other types of income.
- It can limit the potential to earn more income.
- Income is limited to the time you devote to the activity.
Definition of Financial Liabilities
On the other hand, liabilities are all the assets and instruments that generate constant outflows. They are payment obligations, debts, acquired commitments, taxes, purchases, and regular expenses that we make.
Many people do not understand that many of the things they consider an asset are, at least while they are owned, a liability.
For example, a private vehicle may appear to be an asset to a person who buys it with the purpose of selling it two years later, betting on a rise in the price of automobiles.
However, during the two years in which the vehicle is owned, it will require fuel, spare parts, maintenance, and other items that constitute expenses, i.e., outlays.
Differences between Assets and Liabilities
Let's go deeper: the central difference between Assets and Liabilities is that assets put money in your pocket and grow your wealth, while liabilities make you spend money, prevent you from saving and compromise your income.
Assets are savings, income, and wealth. Liabilities are spending debt and outgoings. Assets add money to your personal finances, as opposed to liabilities, which take money away from your wealth and reduce it.
Therefore, you should ask yourself if what you spend money on generates benefits or provides expenses.
What do Assets and Liabilities have in Common?
However, liabilities and assets are not entirely different since they have elements in common. In principle, because to acquire both you must spend money. Also, many assets can be tangible goods.
Therein lies the main similarity between assets and liabilities: in both, money is spent for their acquisition. But, in one case, the expense is just that, and, in the other, the expense becomes an investment.
How to Know if You Have Assets or Liabilities?
Do you have doubts? Let's review some practical examples. Let's start with a typical case: purchasing a cell phone. If we buy it because we want to renew our equipment or because we are attracted by a new model that came out on the market, it is undoubtedly a liability.
But if we bought the phone because we got a new job that involves cell phone use, then we have an asset since the money spent will be compensated with the income.
At El Paisa Multiservices we want to help you with your finances in Hartford, CT. You can contact us if you have questions about our services.
By Ingenuity & Solutions
