I’m sure we all wonder at some point in life “how can I become rich?” or “how do millionaires make their money?”. The truth is that most millionaires or even billionaires are just like every other person on the planet but with one major exception: they have multiple income streams.
So why do most ‘ordinary people’ only have one income stream from a regular job?
Think back to when you were growing up, this probably sounds familiar to you: “Go to school, study hard and get a high-paying job.”
You see, most people are not programmed to become wealthy. Instead, they’re wired to find a job without knowing there are other ways of making money outside the regular 9-5 grind, such as starting your own business or investing in high-return assets. In order to create wealth, you need to know how to build multiple streams of income, besides just working a job and receiving a salary.
In this article, we dive deeper into the benefits of diversified income and discuss how many streams of income you should actually have to be financially successful.
Why is it important to have multiple streams of income?
One of the best ways to become financially successful is by having multiple sources of income. However, diversified income is not only great for your financial wellbeing but can also open up new opportunities in life. After all, most of us don’t want money for the sake of it but for what it can offer us. Here are some benefits that multiple streams of income can have in your life:
1. Financial stability
More stability and security in the event that one source stops generating an income, or if there is a reduction in revenue from one source. This could happen due to a job loss or illness, for example. If the pandemic has taught us anything, it’s that neither jobs nor health can be taken for granted. Diverse income streams will offer you something to fall back on.
2. Paying off debt
Paying off your credit cards, high-interest consumer loans or even a mortgage is a great use for an extra income stream. If you can avoid paying tons of interest on a loan by making extra payments, you will be better off financially.
3. Building emergency fund
An emergency fund is a must in case something goes wrong and you don’t have a regular income for a while. Alternative income sources will help you to build a rainy day fund quicker.
4. Helps to achieve financial independence
Once you have built an emergency fund, paid off your debt and are making enough money from alternative income streams, you have become financially free. At this point, a regular job becomes optional.
5. Allows more risks in life
Investing, becoming an entrepreneur or changing careers all have a level of risk involved. However, this shouldn’t stop you from exploring new ventures. When you have various income streams as a financial backup plan, you can afford to take more risks that might lead to huge rewards both financially and emotionally.
6. Opens up unique opportunities
Financial reasons often stop us from following our passions and dreams. But if you have several sources of income covering the basic expenses, you’re free to pursue your passions.
7. Building wealth long-term
7 different streams of income
Whether your goal is to become financially free or a millionaire or just have some more security for your financial future, you need to have diverse income streams. The idea of having multiple streams of income is to provide a diversification of revenue. This does not mean you should have seven jobs. While a few of these streams can be active, the remainder being passive.
Let’s have a look at seven of the most lucrative and popular ways that millionaires make their money; including both pros and cons for each.
1. Earned Income
Earned income is the money that you earn by doing something or by spending your time. Typically, this is the money that you make in your job, i.e. the salary you get by working for someone else. Earned income is therefore most people’s primary stream of income. Whether you work as a waiter in a restaurant or have an office job, this type of income requires a certain number of hours to be met or a standard of output to be produced.
Earned income is an important first step to building wealth for most of us. Your salary is the source of your initial savings, which you will then use to invest in passive income streams. However, the downside of this type of income is that you are trading your time for money.
One of the main reasons people are not able to go beyond earning money through a job is because they will feel comfortable in that zone. Unfortunately, this comfort zone becomes your worst enemy and stops you from living your dream life. You’ll spend most of your time trying to get more out of it than what’s put into it. But even if you work hard for years, there won’t be enough money coming out on the other side to lead to a truly wealthy life. Therefore, additional income sources on top of earned income are necessary.
“Comfort is your biggest trap and coming out of comfort zone your biggest enemy”
~ Manoj Arora on From the Rat Race to Financial Freedom
2. Profit or Business Income
By selling a service or product for more than they cost you is the basis of profit income. To be an entrepreneur and start earning profits, you will need to identify a product or a service that you want to sell. For example, you could open an online store and sell products or offer professional services as a consultant and charge for your time. Or you can even combine the two.
Making profits as an entrepreneur can take tons of hard work and dedication. It’s not for the faint-hearted, but you can be rewarded with success and money if you put in the time! Profit income usually requires a significant time investment to get started. It’s therefore an active income source, just like earned income. However, depending on the type of your business, you can automate as much of the processes as possible to make this stream of income more passive.
3. Interest Income
You earn interest income when you lend your money out to others. Some common examples include interest from a savings account, real estate crowdfunding or peer-to-peer lending arrangements. Whether monthly or annually, you earn income by collecting interest from where your money is deposited.
This is a great source of passive income because active involvement is not needed once the investment has been made. Earning interest income can be as easy as putting aside your money somewhere with a high interest rate and simply watching it grow on its own during the months and years.
4. Dividend Income
Investing in dividend-yielding stocks is one of the ways of building wealth and receiving a steady stream of passive income. Dividend stocks allow investors to make money in two ways: stock price appreciation and dividend pay-outs made by the company. Dividends are basically a portion of the profits that a company distributes among its shareholders.
There is no work required of you, which makes dividend income purely passive. All you need to do is to invest your money and get paid once a quarter or twice a year, depending on the company.
However, paying dividends is not an obligation for a company. They may decide to cut the dividend pay-outs at any point in time for any reason. Therefore, when choosing a stock to invest in, it’s important to avoid judging a company based on dividend payment alone.
5. Rental Income
You get rental income as a result of renting out an asset that you own. Most common rental income comes from some form of property such as an apartment, a house or a commercial building.
Out of the seven income streams, rental income is one of the most powerful ones. Similar to dividend stocks, property investment typically also increases in value over time. Did you know that house prices in the UK have increased by 67% in the past 10 years? We will discuss capital appreciation further in ‘Capital Gains’ section below.
Nevertheless, there are two main downsides to this type of income. First, it requires a substantial initial investment. Secondly, although you will get regular rental payments, releasing the cash invested in the property can be time-consuming. Therefore, it can be difficult to liquify this asset quickly if needed.
6. Capital Gains
Capital gains are a form of income you make as a result of selling an asset that has increased in value. These assets can be anything from high-ticket items such as luxury items and real estate to stocks and shares. For example, if you buy a house for £250,000 and sell it for £280,000, the £30,000 increase is your capital gain. Or if you buy Bitcoin for £500 and sell it later for £600, you make £100 in capital gains.
Although capital gains can offer you an opportunity to make a lot of money, it’s not always guaranteed that your investment will increase in value. You might even lose money if you are rushing to sell at the wrong time when the market is down. For instance, many property investors prioritise regular cash flow, i.e. rental income, over capital gains because it can be difficult to forecast property prices correctly.
7. Royalty Income
Royalty income is a source of passive income generated by designing or making something unique and charging others to use it. Musicians are a prime example of this. Let’s look at Mariah Carrey as an example. Every December, the singer makes around £400,000/$550,000 in royalties from “All I Want for Christmas is You” – all without having to lift a finger since she recorded the song in 1994!
Another example would be a franchise business such as Subway, McDonald’s or Dunkin’ Donuts. They earn royalty income by letting the franchisee business owner use their processes, logo, marketing and so on.
The biggest challenge with this type of income stream is to create something unique that can be repeatable. However, once created, there’s virtually no limit to how much money you can make.
So, how many streams of income do I need?
Regardless of your financial and life goals, remember the good old saying “don’t put all you eggs in one basket”. This doesn’t necessarily mean you’ll need to have all the seven streams of income at once. But you’ll certainly need more than one if you want to secure your financial future and create wealth.
Not all millionaires or even billionaires have seven main sources of income either. For example, Bill Gates became one of the richest people on the planet through Profit and Royalty Income. At the same time, Warren Buffet earned his fortune with Capital Gains and Dividend Income.
But here is the truth about millionaires: you won’t find wealthy individuals with an income stream from the ‘Earned Income’ category alone. And the reason for this is very straight-forward. This stream is where our time utilisation is the least efficient. The other six streams of income however are not directly time-dependent, and hence can leveraged well to generate wealth.
To wrap up, having seven streams of income may seem like a lot initially, but it’s all about finding the right mix for you. The underlying learning here is to not be dependant on only one income stream where you are actively involved. Explore your strengths and interest, and make the most out of what you got. It might even be life-changing for you and the generations to come.