Difference Between Active and Passive Income: Everything You Wanted To Know

By Ishmohit Arora

What is the real difference between active and passive income?

Active income, explained simply, is the income for which you have to perform some services. This includes salary, commissions, business income, etc. Simply, it is the type of income in which you have to put in some effort (work) to make money. On the other hand, passive income is the type of income in which your money works for you. For instance, rent from property, dividend and gains from stock market. Both forms of income are significant, and one can lead to the other because passive income allows development of a stream of income into a pile of capital.

Warren Buffet

To quote Warren Buffett

“If you don’t figure out a way to make money while you sleep, you will work until you die”.

Thus, passive income provides a way for you to accumulate wealth and meet your financial goals overtime.

The secret of passive income lies in understanding the power of compounding. Einstein had emphasized upon this power, by calling it the eighth wonder of the world.

All the great investors and wealthy people understand the power of compounding. For instance, in his letter Buffett (1962) shared the anecdote of Queen Isabella of Spain sponsoring Christopher Columbus’ voyage in 1492, to find a ‘new world’ at a cost of approximately US$ 30,000. Buffett called it a low-compound investment, as the same money invested at 4% compounded annually would have amounted to approximately US$ 2 trillion by 1962 (or 470 years later).

This is the power of compounding you must understand and utilize, as investing your savings and benefiting from the subsequent compound interest will enable you to achieve your long term financial goals like retirement, buying a house, child education, etc. Harnessing this in your life can help you achieve financial independence and you can pursue your passions.

How to achieve it?

Nifty Index Pep Talk

The easiest way to achieve this, is by investing in the Indian economy which is growing at 7-8% (GDP) without accounting for inflation which is approximately 5%. By investing in the Indian economy, I mean starting a SIP in Nifty Index fund. For Instance, a SIP of 5000 rupees per month for 20 years in NIFTY becomes 74.86 lakhs, assuming an annual return of 15%. Another way is to start as early as possible. Warren Buffett remarks, “ I made my first investment at age 11. I was wasting my life until then.”

The earlier you start (investing) the better it is, as your money compounds for a longer period of time. For instance, a SIP of 5000 rupees for 30 years in NIFTY would grow to 3.46 crores, as compared to 74.86 lakhs in 20 years. Therefore, if someone asks you what is the best time to invest in order to meet your financial goals, your answer should be right now. You reap what you sow. In the case of compounding, the earlier you sow, better the harvest is.


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