Detailed Explanation
Income is money that flows into your personal finances. It’s the foundation of your ability to save, invest, and build wealth.
Types of Income
Earned Income: Money received in exchange for work-salaries, wages, tips, commissions, bonuses, and freelance earnings. Most common and typically highest-taxed.
Investment Income: Returns from investments-dividends from stocks, interest from bonds and savings, capital gains from selling assets.
Passive Income: Money earned with minimal ongoing effort-rental income, royalties, business income from operations you don’t manage.
Portfolio Income: A subset of investment income specifically from selling assets at a profit (capital gains).
Gross vs. Net Income
Gross income: Total earnings before any deductions.
Net income: What remains after taxes, insurance, retirement contributions, and other deductions. This is your actual take-home pay and what you budget from.
Income and Financial Independence
The path to financial independence has two levers: increasing income and decreasing expenses. Income determines your ceiling-how much you can potentially save and invest.
Examples
Monthly Income Breakdown
| Source | Amount | Type |
|---|---|---|
| Salary | $5,500 | Earned |
| Side hustle | $800 | Earned |
| Dividends | $150 | Investment |
| Rental property | $400 | Passive |
| Savings interest | $25 | Investment |
| Gross Total | $6,875 | |
| After taxes/deductions | $5,200 | Net |
Why It Matters
Understanding and tracking income is relevant for financial planning:
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Budget Foundation: Income determines how much you can allocate to expenses, savings, and investments.
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Savings Rate Calculation: You need accurate income figures to calculate and improve your savings rate.
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Tax Optimization: Different income types are taxed differently-understanding this enables tax-efficient planning.
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Goal Acceleration: Income growth is one of two paths to faster goal achievement (the other is reducing expenses).
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Diversification: Multiple income streams provide security and reduce dependence on a single source.
Tracking all income sources in a spreadsheet can reveal the overall earning picture and help identify different revenue streams.