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Residual Income Definition – Overview & How to Calculate

Residual Income Definition – Overview & How to Calculate

Anyone who is looking to create wealth, or simply operate a low-effort side hustle, has likely heard of residual income. While it might seem complex from the outside looking in, once you are familiar with what residual income is and some ways to potentially generate it, you will be on your way to financial independence.

Residual income is income that you continue to make, even after the initial work is completed. This residual income is often contracted into many types of creative work, such as music and books, but can also be seen across many different industries like real estate rental and stock dividends.

There are a lot of intricacies to residual income, as well as countless ways to potentially create or earn residual income. We're going to do a deep dive into residual income and what it can potentially do for you. We're going to start with what residual income is, both in personal and corporate or business context, and why it's important. We'll also cover a common calculation of it and some solid and actionable ways you can begin creating your residual income quickly.

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Definition Of Residual Income

Residual income can mean a variety of things, depending on the situation and context in which it's used. In terms of personal finance or small business applications, residual income is income that continues to be received by the creator or original artist long after the product, piece, or work is created.

It can also be defined as the income that is received or remains once all debts and obligations of the creator have been settled. This initial income-producing work can span nearly all industries and sectors and includes many types of income & revenue.

In the world of corporate finance, residual income is any excess income earned by an investment, taken in the relative context of the opportunity cost of the capital used in the investment. Residual income in the corporate finance world can be used as a performance metric indicative of overall company performance, where the income generated is evaluated by an individual or team once all relevant capital costs have been paid.

It is important to note that one other unique trait of the definition of residual income is that it must come from a source other than a direct employer or contractor. The IRS has an even more narrow definition and counts residual income only as income received from rental property or a business in which you do not actively hold a participatory role.

What Is Residual Pay & How Does It Work

The key to understanding residual income is that it is only measured as the net amount left when all of the required costs of capital needed to generate that income are taken into account and quantified. It is also sometimes referred to as passive income, added economic value, and economic profit. The term "abnormal earnings" is also used, though this is becoming less common with the rise in individuals and small businesses generating residual income.

The way that residual income works for the average person is much easier to understand when you apply it to an example. One of the most popular ways that someone interested in creating residual income or passive earnings is to invest in stocks that pay dividends, as most will pay dividends per share every month or quarter. Some people aren't aware of how those work, so let's go a little deeper.

If you wanted to create residual income from a dividend-paying stock, you would need to find one that applies to your budget and risk tolerance and buy at least one share. In some cases, the broker that you go through may offer the ability to buy fractional shares, in which case you wouldn't even need to buy an entire share. For this example, you find a stock that pays a monthly dividend, which is based on the relative price of the shares and the performance of the company, and you buy one share for $10. That one share entitles you to a dividend of 1.4%, for example, meaning you'll get $.14 each month for each share you own, provided the dividend stays constant.

While $.14 may not seem like much, it's not likely that you're going to invest just $10 and kick back waiting for retirement. You're going to continually purchase shares, similarly to continue saving money with each paycheck, but your dividends compound.

This is why residual income is so powerful for people like authors, musicians, and celebrities. Every time someone buys your album, plays your song, buys your book, or uses your service, the residual payment goes to the creator. When you have thousands or even millions of those small payments, that residual income can become incredibly powerful.

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Why Residual Income Is Important & How To Calculate It

Residual income is important for anyone hoping to build wealth or establish financial independence because it only involves a set amount of effort or investment to initially establish. Once the income-producing work or property exists, it will continue to earn the creator income, in many cases without any further need or ongoing obligation from the creator.

Residual income on a personal level is counted as disposable income. This is because it is calculated after all other debts and obligations are taken into account, which makes it a crucial component for those trying to secure either a personal or small business loan. This is also why it's important for those hoping to track the residual income they've created to know how it's calculated.

The calculation starts with adding all of the costs incurred in creating the income-generating work initially. For someone who creates graphics for digital sales, for example, this cost would include the time they spent creating a particular image, as well as a portion of the cost of the computer equipment needed to create their images. If they work from home, part of their calculations will also need to take into account their living expenses, considered in the context of how many images they create each month and what they earn from sales.

This is all taken into account on a per-item basis, no matter what the income-generating work is. Only the expenses, wear and tear, and cost of investment for that particular item can be included in the residual income calculations without skewing them. Once all of the debts, bills, and other obligations are taken out, what's left is the residual income. It is considered purely disposable income,

Ways To Create Residual Pay

There are countless ways to create residual income, with some being much more involved than others, and all with varying income potential. Some may require a certain ability or talent, while others can be learned like any other skill. Most will require some form of initial investment on your part, often an investment of time and effort or start-up cost. Here are some of the most popular and powerful ways to create income that continues to generate whether you're working or not.

  • Dividend Stocks & Funds – Dividend stocks are a way to put your residual income on autopilot. Many brokers and funds allow you to set your dividends to reinvest, letting you compound your residual income much faster, snowballing your passive income.
  • Investing In Real Estate – By renting out a property that you have invested in, you can create significant monthly income. This is one of the most popular investments of the very wealthy.
  • Creating Music – Creating music is a great way to earn residual income. You will receive a cut of the proceeds every time someone buys your album or single.
  • Publishing A Book – You don't have to write a whole novel; you can write short e-books and self-publish, earning residual income each time someone buys your book.
  • Create A Course – Platforms like Udemy and others allow you to create your own course or micro-degree, and people can pay to take it.
  • Affiliate Marketing – Suggesting products for people that solve a need or problem they have and becoming an affiliate for the seller is a great way to make passive income. Platforms like Amazon allow you to become an affiliate easily and earn a percentage from each sale that your affiliate link generates.
  • Social Media Influencer – Leveraging social media popularity, blog content, or streaming platforms to create content and gain sponsorships can be a powerful way to earn residual income.
  • Creative Production – This includes things like creating digital graphics that you can put on sites like Redbubble or Cafepress, which people can purchase and have put on countless different products. With the power of memes and slogans, this holds massive potential for income generation.

Similar post: Debt to Asset Ratio – What It Means & How to Calculate

There Is A Lot To Know About Residual Pay

If you hope to be able to become financially independent, even retiring early, knowing all you can about residual income and passive earnings will help you get there. There's a lot to take in and consider when you're planning your future revenue and income streams, but with a little strategizing and some solid motivation, you'll be pulling in extra money each month in no time.

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