What is Earned Income?
Earned income (sometimes called active income) is linear income you earn through working. Essentially you trade your time and skills for money and there is usually a direct correlation between the amount of time and the money earned.
This type of income is usually limited by the time and skills you personally have. Therefore, trying to earn your way to wealth is an arduous, inefficient way of generating wealth. You can only work so many hours and add so much value by yourself so that your earnings will ultimately be capped at a certain level. When it comes to earning your income, you're the golden goose and if you were to rely exclusively on yourself to generate wealth the golden goose will eventually cease to produce income as a result of overwork or perhaps even ill-health. It's important also to remember that as you age, your physical or mental capacity will reduce and so you will sooner or later have to start supplanting your active income with passive and portfolio income.
Time and Tax - 2 Limiting Factors in Wealth Creation
There are 2 main shortcomings of earned income:
- Time - or more specifically said 'Your Time'. Earned income requires you to trade your time for money. Time is a limiting factor i.e.the amount of time you are willing or able to invest. As soon as you stop working, you stop making money. No matter what, there are only 24 hrs in the day and you can only reasonably expect to work 8 of those on average over the long term.
- Tax - this income is the most heavily taxed form of income plus the more you earn the more tax you pay. Personal tax rates in the US range from 10% to 35%. However, it is also subject to other taxes as well, such as social security (12.4% (half paid by employer) and Medicare taxes (1.45%). Therefore, if you are a relatively high earner your income could be taxed at true rate of almost 50%! Ouch...that hurts!
One huge benefit of earned income over the other income types is that you generally don't need any startup capital in order to start making earned income. Hence, most people rely on earned income from the start of their working life.
Can You Become Wealthy from Earned Income?
Most people work for earned income...most people aren't wealthy. Regardless of your definition of wealth you will never be truly wealthy if you are relying exclusively on monthly earned income. You can end up in an endless cycle of earning income and paying bills. That said, used correctly, earned income can be a good way to start your investing and wealth creation endeavors, so long as you save minimum of 10% of your income with a view to accumulating a lump sum of cash. This lump sum of (i.e. capital) can then be used to generate the other two types of income. In addition to saving a percentage of your earned income you could also look to reduce your debts by allocating part of your earned income to accelerating the reduction of personal debt which is eroding you wealth.
Building wealth and achieving success shouldn't be about extracting every last ounce of your own energy and resources to get there, for that carries a huge personal cost and can sometimes prevent you from sustaining this success. If you're serious about wealth creation and learning how to become rich than you will have to make the leap from relying on active income and start generating passive and portfolio income as soon as you possibly can.