• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to secondary sidebar
  • Skip to footer

Dividends Diversify

Building Wealth One Dividend At A Time

Rakuten banner ad
  • Home
  • Investing
  • Dividend Stocks
  • Building Wealth
  • Money Management
  • Financial Independence
  • Resources
  • About
    • Contact: Advertisers/Media
    • Site Archives
    • Disclaimer & Privacy
    • Blogroll

What Is Portfolio Income And Why Is It Important?

By Tom 12 Comments

Share
Investing is the main way to generate portfolio income

A key point to building your wealth revolves around this critical question: what is portfolio income?

Your income is the engine that drives the amount of money you will have in life.  In this article, I will explain the 3 different types of income.  And why the third type, portfolio income, is so important to have more money.

Raise your hand if you would like to have more money.

Once I understood portfolio income, I made better decisions about jobs, work, money management, and life.  You can too!

Also, knowing the answer to the question “what is portfolio income?” helped me to build my finances faster.  And, retire earlier.

So, let’s get started by identifying the 3 types of income.

Related: 3 Vanguard funds to increase your income

What Is Portfolio Income vs. Earned Income vs. Passive Income

What is portfolio income?

I think there is a lot of confusion in the personal finance community about different types of income.   By knowing the 3 types of income, you will better understand what portfolio income is.

Here are 3 types of income.  Let’s understand them and answer these questions in the following order.

  1. What is earned income?
  2. What is passive income?
  3. What is portfolio income?

Related: How to build a portfolio of blue-chip stocks paying dividends

What Is Earned Income?

Earned income is also known as active income.  There are 2 ways to make earned income.

First, a person earns income through wages from a job.  In other words, you work for someone who pays you.

Second, earned income can also come from making money through business ownership.  Essentially, you own AND run a business.

Before we go on, let’s clarify business ownership.  You probably know, I make money from dividends by owning stock in companies.  Therefore, I own a piece of those businesses.  But, that does not qualify as earned income.

Why not?  Because I do not actively participate in the businesses in which I own stock.  So, only income from a business you actively participate in qualifies.

Examples of Earned Income

It may seem obvious from the definition, but to be clear, I will lay out a few examples of earned income.

Paycheck From Your Primary Job

You know what this is:  working for “the man” or “the woman”.

Paycheck From Part-Time Work

Maybe you have a second, part-time job to make ends meet.  Or, you work part-time in retirement to stay active.  Either way, this is earned income.

Paycheck From A Business You Own AND Work For

Now you are the man!  But, you draw a paycheck from your business.

This is how my Dad went about building his finances back in the day.  He owned and operated a business with a couple of employees.

My Dad was also an employee and worked at his business 6 days a week, sometimes 7 during his busy season.  For that effort, he received a regular paycheck.  And that paycheck was earned income.

Money Drawn Out Of A Business That You Own

In this example, you are still the boss girl.  And, there is nothing wrong with that!

But, there is no paycheck involved.  You just pull money out of your business when you need it.

As an example, that is how my blog works.  I make money from marketing activities and advertising. 

That money is deposited in a separate bank account.  When I want the money, I pull it out of that account and do with it what I choose.

Money Made Side Hustling

It seems like everyone has a side hustle these days.  If you make money walking dogs for Rover or giving rides through Uber, you have earned income.

Tax Implications Of Earned Income

Taxes are one of the worst parts of earned income.  Why?  Earned income is heavily taxed.

I won’t bore you with a tax lesson here.  But in a worst-case situation, every extra dollar of earned income can result in the government taking at least 50% of those extra dollars.

Thoughts On Earned Income

Earned income is the type of income everyone in the financial independence community is trying to get away from.  Why?  You are trading your time for dollars.

You do not have financial freedom.   And you are dependent on that next paycheck from the boss.

The boss owns your time.  And with every paycheck, federal and state governments take a large share.

Now, there is one big benefit to earned income.  You must have earned income to participate in and make deposits to qualified retirement accounts.

Qualified retirement accounts include the 401(k), 403(b), traditional IRA and Roth IRA.  Taking advantage of the tax breaks these accounts offer is a great way to build long term wealth.

What Is Passive Income?

The true definition of passive income is very narrow.  It is different than what I often see discussed on the internet.

I see articles titled something like “50 passive income ideas…”.  Then fill in the blanks.  Passive income ideas to build wealth, quit work, work from home or be financially free.  You name it, and it’s out there.

And that is okay.  Articles like that just take a very liberal approach to passive income.

The liberal and informal definition of passive income is money outside of your full time 9-5 or 24/7 job.  Working from home is often included in this loose definition of passive income.

However, if the income results from an active endeavor, it is not passive income.  And oftentimes, passive income is confused with portfolio income.  So, we will get to the main point of this article in a moment, what is portfolio income?

But before we do that, here is the strict definition of passive income.

Passive income is any rental activity or any business activity in which an individual does not materially participate.  And, there are very specific rules that define what material participation is and is not.

Examples Of Passive Income

So then, what qualifies as passive income?  Here are the primary examples.  It is income from:

  • Renting equipment
  • Renting real estate
  • Owning a business in which you are not involved

That is all that qualifies as passive income.

Thoughts On Passive Income

Passive income is, well, truly passive.  It is what we all dream about.  That is, making money while we sleep.  Taxes on passive income are also lower than taxes on earned income.

But let’s be honest with ourselves.  Outside of renting a real estate holding or two, making passive income involves activities that most of us cannot or do not participate in.

What I mean is that it takes a rare and special person to own a successful, profitable business in which they are not actively involved.  Most entrepreneurs spend large amounts of time managing their business.

Also, if you become actively involved in renting a large number of real estate holdings, it is no longer considered passive income.

What Is Portfolio Income?

This brings us to the major point of this article.  What is portfolio income?

Portfolio income is interest, dividends, or capital gains.  It is derived from investments or money lent.

Related: 60+ assets for capital gains

Here is another way to think about portfolio income.  Portfolio income is generated from “paper assets”.   Owners of these types of assets generally have a piece of paper signifying their ownership.  Or, at least they used to.

Many forms of paper assets, like stock certificates and loan agreements, have gone away in this age of digitization.  But the term “paper asset” remains. 

Examples of Portfolio Income Assets

examples of portfolio income

There are many examples of assets that can generate portfolio income.  Sometimes they are called income-producing assets or income-generating assets.  Here are several examples :

  • Savings accounts
  • Certificates of deposit
  • Saving bonds
  • Money market accounts
  • Municipal bonds
  • Corporate bonds
  • Private loans
  • Peer-to-peer lending
  • Preferred stocks
  • Dividend-paying common stocks
  • Open-end mutual funds
  • Closed-end mutual funds
  • Exchange-traded funds
  • Real estate investment trusts (REITs)
  • Master limited partnerships (MLPs)
  • Options

Related: Income assets for making money

Taxes On Portfolio Income

Portfolio income from dividends, interest and long term capital gains get preferred tax treatment.

Dividends and long term capital gains are taxed at lower rates.  Also, portfolio income is not subject to Social Security and Medicare taxes.

Why Is Portfolio Income Important?

Goal number 1 for this article is accomplished.  I have answered the main question:  what is portfolio income?  But, I also promised to discuss why portfolio income is so important.  Here’s why:

Passive income, at least by the strict definition, is hard to come by for the average Joe or Jane like me.  On the other hand, anyone with excess cash can use that cash to build a stream of portfolio income.  That’s exactly what saving and investing for retirement is all about.

In more liberal terms, portfolio income is for all intents and purposes, passive.  Yes.  You have to invest in and manage a portfolio of holdings across a variety of asset classes.  But, there are ways you can automate that process.  In other words, set it up and forget it.

Portfolio income earns your financial independence.  Build enough portfolio income to cover your expenses and you will no longer have to “answer to the man” every day.

Portfolio income is more tax efficient.  It is not subject to the highest tax rates like earned income.  This is important.  The burden of taxes can be one of the largest obstacles standing in the way of building one’s wealth.

Related: 13 examples of portfolio income-generating assets

Conclusions – What Is Portfolio Income And Why Is It Important?

Portfolio income is neither earned income nor passive income.  By definition, portfolio income is interest, dividends, or capital gains.  It is derived from investing or lending money.

Earned income is important, especially in our younger years, but it has its drawbacks.  Also, passive income based on the strictest definition is not available to average folks like you and me

Life can be a lot better in the long run if you use excess earned income to build portfolio income.  Why?  Portfolio income buys your financial independence.  And, it is tax efficient as you go about building wealth.

Now we know what portfolio income is and its importance in wealth building.  In an upcoming article, I will discuss how to increase portfolio income.

Note: Article inspiration from GenYMoney.

Disclosure & Disclaimer

This article, or any of the articles referenced here, is not intended to be investment advice specific to your situation. I am not a licensed investment adviser, and I am not providing you with individual investment advice. The only purpose of this site is information & entertainment. We are not liable for any losses suffered by any party because of information published on this blog. See this site’s Disclaimer and Privacy tab for more information.

Share

Filed Under: Investing

Reader Interactions

Comments

  1. Miguel (The Rich Miser) says

    November 11, 2019 at 9:38 am

    Hi Tom,

    This is good to know. I used to call my portfolio income passive income. It helps to correctly categorize it, and try to increase it as much as possible (right now it’s mostly reinvested).

    Cheers,
    Miguel

    Reply
    • Tom says

      November 11, 2019 at 10:12 am

      Hi Miguel. I use the terms a bit loosely myself. I try to reinvest as much of mine as possible too! Tom

      Reply
  2. Joe says

    November 11, 2019 at 10:48 am

    If you’re really strict, you can’t include real estate income in passive income. You have to make decisions even if you have a manager to run the day to day operation. They’ll call you when repair is over a certain amount or if roof leak or a neighbor is causing problem. I don’t think real estate is truly passive.
    The only thing that’s truly passive is royalty income. If you create a book, song, or something like that.
    Anyway, my definition is very loose. Portfolio income is way more passive than rental properties. To me, both are passive income.

    Reply
    • Tom says

      November 11, 2019 at 11:38 am

      Thanks, Joe. I appreciate your perspective stemming from your experience renting properties. Tom

      Reply
      • GYM says

        November 12, 2019 at 1:31 am

        Some people even might consider a blog as passive income too! In a way some aspects of it are passive…

        Portfolio income can be very passive but you still have to make sure you’re invested in the right and companies.

        Reply
        • Tom says

          November 12, 2019 at 7:56 am

          Interesting GYM. I’m not sure of blog income being passive. I have never worked so hard for so little! But I do enjoy it for some odd reason. Tom

          Reply
  3. J says

    November 11, 2019 at 10:51 am

    “However, if the income results from an active endeavor, it is not passive income. ”

    Is a conclusion that the PF community are starting to realise – such an important point!
    Defining portfolio income is the next step and thanks for making it! Naturally, you often have to accumulate capital in the form of the first two before engaging in the third (to a meaningful degree) but people assume you have to reap dividends from a $1m to make it worth it. Portfolio income takes place on the first $1!

    Nice post,
    J

    Reply
    • Tom says

      November 11, 2019 at 11:14 am

      Hi J. Thanks for reading and commenting. But most of all, your insightful comments that add to the thoughts in the article. Much appreciated. Tom

      Reply
  4. DivHut says

    November 11, 2019 at 7:16 pm

    I think it’s important for people to realize the differences between types of income. Too often we are raised to think that the only way to make money is to (earn) “work” for it. As most of us in the DGI space know… there are other ways to bring money in. Eventually we won’t be able to actively earn income. It’s just a fact of life… setting up a passive stream early in life can help out a lot. Thanks for sharing.

    Reply
    • Tom says

      November 12, 2019 at 7:55 am

      Hi DH. Thanks for commenting. You make a good point about earned income. It reminds me of a saying I have always liked: “some people work for money while others have money work for them”. Tom

      Reply
  5. Passive Cash says

    November 19, 2019 at 10:46 am

    Great read! Forgive me if I continue to call my dividend income..passive income. I’m not sure anything is truly passive by definition.

    I was thinking about taxes while reading this. I think portfolio income wins the basic comparison test…but through deductions, appreciation, etc.. we can sometimes pay little to no taxes on passive income.
    Also REITs are considered portfolio income, but many of them are taxed as ordinary income like earned income.
    Just my thoughts!
    Thanks for sharing!

    Reply
    • Tom says

      November 19, 2019 at 10:59 am

      Thanks for your thoughts PC. Very insightful! Tom

      Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Primary Sidebar

Rakuten sidebar ad

Check out these popular posts:

46 Habits of Self-Made Millionaires

How To Become A Millionaire From Nothing

How to Build A Portfolio of Blue-Chip Stocks Paying Dividends

Best Income Producing Assets To Buy & Hold

Apple Dividend & Stock Analysis

How To Build A Vanguard 3-Fund Portfolio Paying Dividends

Vanguard High Dividend Yield ETF (VYM) Review

60+ Investment Assets That Appreciate In Value

Follow Dividends Diversify on Social Media

  • Facebook
  • Pinterest
  • Twitter

Secondary Sidebar

Subscribe & Receive Our Newsletter

Financial Resources

Footer



Dividend Growth Stocks
Dividend Growth Investor

Hi & Welcome:

Welcome to Dividends Diversify! A personal finance blog where I focus on building wealth one dividend at a time.

What I do:

I enjoy investing for passive income through dividend growth stocks.

Who/What I am:

I’m Tom.  A 50 something, early retired, life long investor who loves to share his everyday expertise about:

  • Investing
  • Dividend Stocks
  • Building Wealth
  • Money Management
  • Financial Independence

What I’m not:

I am not a licensed investment adviser, and I’m not providing you with individual investment advice.

Site Disclaimer:

This site’s only purpose is information & entertainment. Nothing presented is to constitute investment advice.

We are not liable for any losses suffered by any party because of information published on this blog.

Subscribe

© Copyright 2017-2019 · Dividends Diversify LLC · Please Read Our Disclaimer & Privacy Policy