Residual Income: What It Is and How To Build It
One way to stay on top of your finances and be more financially flexible is to understand residual income, also referred to as disposable or discretionary income.
A thorough grasp of the concept of residual income will enable you to save, invest, pay off monthly debts, and feasibly plan on taking better care of yourself. Growing a solid residual income will replace anxiety with peace of mind and financial security.
If you’ve thought about building several streams of passive and residual income to live off and those that bring in revenue, even when you’re sleeping. It’s doable! Keep reading to learn what residual income is and how to build it.
What Is Residual Income?
Residual income is the regular revenue that comes after investing your initial resources and time. Rental income, interest, dividend payments, artist royalties, and dividend payments are some examples of residual income.
Residual income also refers to the amount of money or excess income you’re left with after you’ve deducted expenses such as credit card bills, your mortgage, groceries, utilities, and car payments. Many people use the residual income for debt repayments, savings, or a vacation.
Residual income may mean slightly different things in personal finance and corporate finance. Within personal finance, it refers to your discretionary income — the net amount you remain with after clearing your bills, personal debts, and other financial obligations.
Corporate residual income refers to the measure of company performance as depicted from the total net revenue generated after deducting relevant capital costs.
In a nutshell, residual income is:
- The amount you’re left with after footing bills and paying operating costs.
- The revenue you continue to generate after investing time and resources and the work is done.
Types of Residual Income
Here are six common types of residual income:
Personal Residual Income
Residual income in personal finance is synonymous with your monthly disposable income—the amount you’re left with after meeting all your monthly financial obligations.
Your residual income is a key consideration for lenders, and the more the residual income, the higher the amount you qualify.
Personal residual income also refers to the amount you earn continuously without active involvement. For example, you write a book and earn royalties from book sales. Once you publish the book, you do not need to actively participate in the marketing and sales process to earn an ongoing income.
Corporate Residual Income
In the corporate setting, residual income is the amount left after paying all capital costs. It’s the company’s net operating income.
The company’s residual income is used to assess the performance of a capital investment, a department, a team, or a business unit. The income that a company earns continuously without needing continuous active involvement also makes up corporate finance residual income.’
For example, if a company invests in another company and earns dividends. The corporation will keep earning dividends without further active involvement. The same goes for a corporation’s rental properties — once bought, the company will earn annual rental income almost passively.
Stocks as residual income is a valuation method used to estimate the intrinsic value of a company’s common stock. Stocks account for the capital cost —debt and equity used to finance the company’s operations.
The valuation model for stocks accounts for the sum of the present value and book value of expected residual income in a clearly defined future. Residual income will be the amount left after deducting the opportunity costs for the company’s capital sources.
Residual income is the net income less equity charge.
The equity charge is calculated by multiplying the value of equity capital and the equity cost.
Residual income equals Net Profit – Equity Charge
The equity’s opportunity cost may see a company register positive net income and negative residual income. A positive residual income is realized when there’s money left after deducting all the production costs.
Stocks pay dividends and provide an ongoing income to investors without needing continuous active involvement. You can invest the dividend stocks to compound returns over time, potentially offering more income in the long run.
Real Estate Investing
Investing in real estate is a type of residual income because you do all the work upfront so that the investment can give you monthly payments. You can accrue income with rent payments when you rent out the property.
Real estate investments can generate residual income through the following:
- Rental income
- Capital gains from property appreciation
- Deductions from property taxes and related benefits
Bonds let you have an ownership stake in loans taken by governments and companies. You receive fixed-rate interest payments twice a year. When the loan matures, you can reinvest in other bonds, and this way, you can have consistent cash flow.
Bonds are a type of residual income because you’re still earning an income even though you’re not directly active in each step of the process.
Royalties and Intellectual Property
A royalty is a specific amount of money you get as the owner of a product or patent from those using your product or patent on a one-use or ongoing basis.
You can earn royalties from your intellectual property, assets, resources, or copyrighted material. The income you earn in royalties comes after you do all the necessary work up front and release the product to the market.
How To Calculate Residual Income
The residual income formula is quite simple. Subtract your monthly expenses, like car payments, mortgage payments, and student loans, from your net monthly income.
Residual income = Operating income – (minimum required return x average operating assets).
Here’s an example of how to calculate residual income:
Suppose your take home is $6,000 per month (your total net income). And your monthly expenses are as follows.
- Rent: $2,500
- Student loan: $500
- Credit card: $400
- Utility bills (cable, phone, internet): $450
- Gas: $200
- Groceries: $500
- Car payment: $350
- Insurance: $250
- Miscellaneous expenses: $300
Your monthly expenses total up to $5,450 per month.
Using the formula, residual income = net income – total expenses, $550 is your residual income.
$6,000 – $5,450 = $550
Residual vs. Active vs. Passive Income
Residual Income vs. Active Income
Active income is the amount you make when you’re actively involved in a cause or offering a service. You earn active income through salaries, hourly wages, tips, commissions, and net profit from running your own business.
You mostly earn active income if you’re employed, freelancing, or involved in some side gig.
On the other hand, residual income is the money you’re left with after meeting your monthly financial obligations, such as car payments, rent, car payments, and utilities.
Residual Income vs. Passive Income
You’ve probably heard the term residual income being used interchangeably with passive income. The two terms don’t exactly mean the same thing.
Passive income is the money you make with little or no effort. Passive income comes in the form of dividend stocks, renting a room on Airbnb, economic profits, and any other residual income stream.
Residual income, on the flip side, is the money that remains after footing your monthly bills and meeting your financial obligations such as rent, utility bills, and student payments.
Put another way, you can use a passive income stream to boost your monthly residual income. For instance, stock dividends may boost your total residual income. However, your residual income may not always be from passive income sources, like in the case of spending more to publish a book only to earn less in passive income —negative residual income.
Both residual and passive income offers you more financial stability and flexibility.
How to Build Residual Income in 13 Smart Ways
If you want more financial stability, freedom, and flexibility, you should build several income streams that add to your residual income.
Here are 13 smart residual income ideas that will care for you even when you’re asleep. All the avenues we discuss boil down to turning your cash into more cash.
1. Invest In Real Estate
Real estate investing is one way to build an ongoing revenue source in the form of residual income. And you can start small by purchasing a home to live in. You’ll be increasing your overall net worth assuming your house appreciates.
You can go a step ahead and purchase a rental property specifically to rent it monthly or boost your annual net income.
You will get a monthly income that will boost your disposable income or offset your mortgage costs if you don’t already own the home.
If you don’t have enough income or assets, you can invest in a joint property with others.
That said, real estate investment is still risky like any other upfront investment. There may be months when the property could be more utilized, and sometimes you lose money when you sell the investment, especially in a market downturn.
So research and weigh your risks as you consider investing in real estate.
2. Short-Term Rentals
You could also boost your residual income by renting out a room or two you don’t use for a short time.
There are multiple short-term rental platforms, such as Airbnb, FlipKey, and HomeToGo. If you’re going on a vacation, you can rent out your own home and make an extra buck if you’re okay with letting strangers stay in your home.
3. Peer-to-Peer Lending
Peer-to-peer lending is another way to build residual income. It works by lending people money, and you earn income when the borrower pays what they’re owed together with interest. P2P lending is common with student loan providers.
Your customers will be those around you, such as friends, colleagues, neighbors, and family members. You’ll potentially earn more through P2P lending than if you put your money in a regular savings account.
The risk with P2P lending is that these loans are mostly unsecured, and there’s little guarantee that the borrower will pay. Do your research and choose the most reputable P2P company, especially one that will allow you to spread your investment through several borrowers to mitigate risk.
4. Invest In The Stock Market
There are two ways to earn residual income from the stock market.
● When your assets appreciate
● Dividend payments from your stock portfolio. Dividends are a fraction of a company’s profits shared with its shareholders quarterly and annually.
Stock market investing is a popular way to grow your retirement fund or save for a long-term goal. You take advantage of the power of compound interest over time, and when primed well, it can be a powerful way to build up your residual income net earnings.
Stocks have been a reliable way of building fortunes and residual income, especially if you know what you’re doing.
Whether you venture into a retirement or a personal investment account, the idea is to find a way of making your money bring in more.
With some research, you’ll find that investing in stocks is not as complicated as it seems. However, you’ll have to invest significant money before you reap substantial residual income.
You can actively participate in the stock market as a trader or set up a robo-advisor account and let the computer algorithms do the work for you. You could also open a brokerage account or build a portfolio of index investments, among other options.
Weigh the risks and make the most informed decisions.
5. Affiliate Marketing And Ads
You earn affiliate income by promoting a company’s products and services through your blog, social media page, or YouTube. You deserve a commission when the reader or viewer purchases through the special link you got from the vendor.
If you can attract an audience and scale it up, you can promote products and services through your blog. Secondly, you can earn residual income by placing ads on your blog or page.
The more traffic you have, the more money you make from services, affiliate deals, and ad revenue.
6. Freelancing and Independent Contract Work
While freelancing may be the least passive income source on the list, it’s still an excellent option for increasing your monthly residual income.
The gig economy’s growth has seen more people taking in flexible side hustles like freelancing and independent contract work.
You can venture into freelance writing, photography, or any other skill in demand and make some money on the side. You may need to invest a little in marketing, such as creating a portfolio website, but you can earn more once set up.
You can combine freelancing with affiliate marketing or earning ad revenue. There are many learning curves in the freelancing sector, but it’s something you can do.
7. Resell Stuff on Online Marketplaces
Many people make a living buying and reselling things online. You can use Craiglist, Etsy, eBay, Facebook Marketplace, and Poshmark.
You can sell your own stuff, used things you bought, and brand-new items. There’s a lot of flexibility in what you can sell online.
You’re in for more residual income if you can make or create art pieces, souvenirs, and photographs.
8. Convert Credit-Card Points To Residual Income
You can take advantage of credit card companies always finding ways to incentivize new customers. When they offer rewards in the form of credit card points and cash back for spending, you could take advantage of that and save some shopping cash.
Make sure you read the terms and rules of the credit company carefully to make the most of the credit card points.
9. Charge Electric Scooters At A Fee
Electric scooters are increasingly popular, and with that comes the opportunity to offer charging services.
The sign-up process to offer these services is relatively simple through your preferred company app. Typically, they’ll require you to provide your bank information for payment. You could have more residual income if you can handle the logistics of charging and returning multiple bikes.
10. Place an Advertisement on Your Car
Yes, you can earn income by making your car a moving billboard. Sites like Wrapify and StickerRide allow you to make a good number of dollars by simply placing advertisements on your car and driving around for a specified number of miles each month.
It can even be better if you’re already using the road for school, travel, or work, as you’ll make residual income without extra commitment.
11. Build and Teach an Online Course
If you have a skill that is in demand, you can convert that to an online course and generate passive residual income from the sale of the course.
Websites such as Teachable and Udemy allow you to create a course, and when you really do a good job upfront, you can begin to make an almost passive income every time somebody signs up for your course.
12. Write and Publish a Book
If you’re an expert in your niche and can help solve a problem, you could package the solution into a book. You could write fiction or nonfiction and make a residual income as you share your knowledge through the book or ebook.
You earn income in the form of royalties or from the Amazon Direct Kindle Publishing platform. Once done and the word is out there, you will earn passive income for years.
13. Make Money Online From Your Photos
If you love photography and can take great photos, you’d be surprised how fast you can generate residual income. Websites like iStock and Shutterstock allow you to create an account where you upload your photos quickly and simply.
Many companies and individual customers can purchase your stock images for ads. Upload the photos consistently, and you can make good money from your photography hobby.
Building one or more residual income streams is a great way to accumulate wealth faster, lead a more flexible lifestyle, and be on top of your finances.
The hard work tends to be upfront when you start building residual income, but once it’s established, you’ll earn income almost passively and be glad you put in the time and resources in advance.
Josh is a financial expert with over 15 years of experience on Wall Street as a senior market strategist and trader. His career has spanned from working on the New York Stock Exchange floor to investment management and portfolio trading at Citibank, Chicago Trading Company, and Flow Traders.
Josh graduated from Cornell University with a degree from the Dyson School of Applied Economics & Management at the SC Johnson College of Business. He has held multiple professional licenses during his career, including FINRA Series 3, 7, 24, 55, Nasdaq OMX, Xetra & Eurex (German), and SIX (Swiss) trading licenses. Josh served as a senior trader and strategist, business partner, and head of futures in his former roles on Wall Street.
Josh's work and authoritative advice have appeared in major publications like Nasdaq, Forbes, The Sun, Yahoo! Finance, CBS News, Fortune, The Street, MSN Money, and Go Banking Rates. Josh currently holds areas of expertise in investing, wealth management, capital markets, taxes, real estate, cryptocurrencies, and personal finance.
Josh currently runs a wealth management business and investment firm. Additionally, he is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses professionally.