Life loves to throw us curveballs. Government regulations, injuries, market changes, and miscellaneous life events such as marriage or having children seem to come around before it’s entirely convenient. John Lennon said it best, “Life’s what happens while you’re busy making other plans.” The best way to prepare for these changes it to avoid putting all your eggs in the same basket and the key to this is income stream diversification.
Mind the Gap
While it would seem like every other post talks about watching expenses, the best way to maintain flexibility in your plans is to be mindful of the gap between your expenses and your income. In an idea world you’re always saving a portion of the money you’re making. This doubles as both a buffer so that you don’t have to dip into savings should your income decline and as a reservoir of capital that you can draw from should there be any emergencies.
Reducing expenses is great, but that will only get you so far. It’s also good to make sure that you have a diversified income stream that can absorb any shocks brought on by external events. There are two main types of income streams: passive and active.
Active income is the traditionally thought of form income. It is limited by the amount of work that you’re willing and able to do. Active income is normally characterized by involving trading hours of your time for a specific rate, or any situation where your income is directly proportional to the amount of work that you do.
Examples of active income include consulting, freelancing, and leveraging the sharing economy using services such as AirBNB & Uber. Active income could also include taking on a traditional part-time job.
AirBNB and Uber are particularly exciting because of their political connotations and the fact that they represent technologies that allow individuals to meet the needs of other individuals. With AirBNB you can list a spare room that you may have on their website and people can rent out your room (or even the whole house if you choose) just like a hotel. Uber allows you to turn your personal vehicle into a taxi. After signing up to become a driver, you can use the app to receive or listen for fares and pick people up as they need rides.
Passive income is the holy grail of income. It represents income that you don’t have to actively work for. The key word here is “actively”. Generating passive income is a lot of work and takes a lot of time to set up properly, but where it out-shines active income is that the upside of your earnings is not limited to the amount of time you spend on it.
For example, if you develop a mobile app that you sell for $1.99 on the app store, your maximum earnings are not capped. You may have only spent 40 hours developing that mobile app, but if if you have 1000 people per month buying it, you can earn $1990 per month (minus any commissions) every month and it costs you no additional time.
Sources of passive income include: rental properties, product-based businesses, e-books, YouTube channels, app development, and affiliate marketing
Of these, some are going to require more time and/or money up front and some are going to be riskier. The idea of creating passive income through rental properties has been around forever, but it does require you to purchase the property and provide upkeep. There will also be additional legal considerations that will vary from state-to-state and city-to-city.
As with anything, there’s a large investment of time and effort required to develop any new income stream. However, it’s well worth the effort. In combination with avoiding lifestyle creep and monitoring your expenses, diversifying your income streams adds significant resilience to your finances and leaves you much better prepared to handle changing circumstances.