Difference between passive income and residual income
Passive income is income earned with little or no effort. Residual income is a form of passive income, which entities earned without any effort. Residual income comes from building any kind of asset that continues to pay you after the work has been done. So, what is the passive residual income in practice? For example, a songwriter can write a song and the next 50 years can receive compensation for that song without any additional effort, without any additional work.
Residual income vs Passive income
The income of a business entity or person is the money they receive for making an investment or providing a service. Though they are sometimes used interchangeably, investors, professionals, and employees should know the difference between passive income and residual income. Passive income is the income that a person makes with very little or no regular effort required. While the residual income may be from passive income sources, passive income is not always residual. Residual income is the discretionary income available for spending to the organization, or person. This income is the amount which is available to the person after all the bills and financial obligations are paid. Specifically, forex traders should be aware of how the forex residual income is calculated
Forex residual income
Forex residual income usually is income earned using expert advisors or signal services in the forex trading industry where the trader usually pays programmers to create trading expert advisors or use forex signals to generate profit. However, profitability is not so high and it is in the range from 15% to 60% portfolio gain per year (based on risk level).
Passive Income – earn while you sleep
Individuals and companies will earn their passive income regularly, with very less or no additional effort. Investments and peer to peer lending are some of the sources of passive income. For tax purposes, passive income is treated differently from the earned income by the Internal Revenue Service(IRS), since it is received from an entity in which the investor is not involved. The salaries, wages, commissions, bonuses, tips received are the earned income since the person is working to make the money. However, for a passive income, the person is an investor, silent part, lender, not the business owner or management.
Persons who have a large enough passive income are able to have enough free time to do whatever they wish, instead of working. Though it is risky to establish a source of passive income initially, it also leads to increased financial security. A passive income source is a great source of security since it is not linked to a person’s time. Even if the amount is not large enough to permit a person to leave his day job, it is good to have an additional income source which will supplement the earned income. Having a large source of passive income can greatly improve the quality of life, especially for a person with more debit or if the person has a dependent who is unwell.
If the investor does not have to spend much time managing his rental property and makes a profit from it, it is a passive source of income. Stocks/shares which are paying a dividend annually are another source of passive income. Though the investor must spend time to find a suitable stock and purchase it, no additional effort is required.
Residual Income in Finance industry
In some cases, legal entities may have a residual income earned without additional effort, from passive income sources. However, the residual income is calculated differently based on whether it is required for equity valuation, corporate finance, or personal finance. More details are provided below:
Personal Finance and residual value
The amount of money that is available with the individual, after he has paid the expenses, personal debt, is the residual income for personal finance calculations. The income level is used to determine whether a potential borrower will be able to repay the loan. To determine whether the loan applicant will be able to afford the mortgage, the bank will calculate the residual income of the applicant, and compare it with the cost of living in the area. The residual income is calculated by subtracting the mortgage payment, taxes, insurance, credit card bills, installment, student loans from the monthly income of the applicant. The remaining amount is the residual income and does not consider food, utility expenses
Corporate finance and residual value
In corporate finance, residual income is calculated as the profit or net income of the company, exceeding the specified rate of return. A company must pay the cost of its capital, and the profit remaining is the residual income. This income is used for assessing the performance of a business unit and determining the capital investment required.
Equity Valuation and residual value
For equity valuation purposes, the residual income is derived from the valuation method and income stream to determine the value of a particular stock. This valuation model for residual income determines the value of a company by combining the book value with the present value of the residual income expected in the future. The residual income is calculated after deducting the capital cost from the net income.
The same rule we can see for forex residual income as same as for stocks. Automated strategy can bring profit to forex trader as residual value.
When the residual income is used for the valuation of investments, it is obtained by subtracting the minimum rate of return from the net income amount.