Diversification is a concept that I’ve embraced all my life. In the past, I discussed investment diversification and also touched on the idea of income diversification. When you think about income…what comes to mind? Most of us will immediately think about our full-time job, and maybe a part-time job.
When you invest, you diversify across different asset classes to reduce risk. The same concept applies for income diversification. You want to diversify your income sources, so you don’t rely only on your job for income.
How to Diversify Your Income Sources
Let’s examine how you can start diversifying your income. For the majority of younger Americans, the income allocation probably looks something like this:
- A significant percentage from their job
- A smaller percentage from their 2nd job (if they have one)
- A tiny fraction from investments — i.e., interest, dividend, and capital gains
Assuming you already paid down your debt, you could start with the basics to start diversifying your income:
- Make sure your savings is earning the highest interest rate possible.
- Move some of your savings into CDs and build a CD ladder.
- Invest in the stock market. If you’re younger, try to invest for long-term growth. If you need immediate income, you can invest in dividend-paying stocks. Make sure you diversify your investment and invest in other asset classes, such as bonds, commodities, and real estate as well.
For example, this is how a more diversified income might look like:
Building Passive Income Streams
Diversifying your income is just the first step. Another equally important goal is to shift your income from active income sources to passive income sources. Shifting toward passive income is essential because to reach financial independence, you need to have enough income generated from passive sources to cover your living expenses.
Here is an image to help you visualize the Active vs. Passive Income Spectrum.
The image above is a simplification that shows active income on the left and passive income on the right. The key difference is how much of your time and energy is required to generate the income:
- Active Income requires a lot of time and energy. If you stop working, you stop making money.
- Passive/Investment Income can continue to provide you with income for months or even years with minimal effort.
Below the scale are various income sources:
- Job – Trading time for wage, tips, salary, or commissions by working for an employer. This is the primary source of income for most of us.
- Consulting – Trading your time and services for a fee, working for multiple clients.
- Running a Business – A business that you are heavily involved with, and it couldn’t operate independently without significant involvement from you. For example, this blog is a business that I am growing.
- Managing Businesses – Partial or full ownership of businesses that can independently operate without your daily involvement, i.e., you have a manager for each business, and you just manage the managers.
- Real Estate Investing – This ranges from you flipping houses (active), managing rental properties on your own, to owning investment properties managed by Property Managers (more passive).
- Investments – Examples include investing in stocks, bonds, REITs, as well as lending via Lending Club and Prosper.
- Royalties – Get paid for your videos, books, artworks, photos, etc. One of my long-term goals is to write a book and make money off royalties.
- Patents – For the inventors among us, owing Intellectual Property is a way to make money through licensing or building a business around it.
Building, Diversifying, and Shifting Your Income
To reduce the risk of losing your income and work your way toward financial independence, you should proactively build, diversify, and shift your income:
- Build the income potential of each stream, especially the passive ones.
- Diversify the numbers of income streams, especially the passive ones.
- Shift income generation from active toward passive income streams.
Regardless of your current success at your job, it would be a mistake to focus on it exclusively. Even if you already have a few income sources, it would be harmful to grow too comfortable and stop experimenting and diversifying. After all, something that works really well today could fail you tomorrow — e.g., losing your job, your profitable restaurant closed down due to violations, your super stock pick went bust due to fraud, etc.
To get you started, take a look at 40+ Extra Income Ideas and Ways to Make Money.
Are you proactively building, diversifying, and shifting your income streams? If you are or have a plan to do so, I would love to hear about it.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.