The three types of income

Over the last decade & half of earning, saving and investing, I have realized that any working professional tends to have three types of incomes. Each of these incomes have a different growth & risk potential and depending on the professional's age and risk taking capacity, they contribute differently to the professional's portfolio.

• Earning income : This is the income that we earn by working - i.e as a compensation for the skills that we learn & implement for someone else. The earning income mostly tends to grow proportionate to the circumstances - growth of the industry, growth of the company, promotion, etc and of course based on the individual's own ability to excel in these circumstances. For professionals working in normal growth companies, the growth in earning income is generally inflation + X %. X being dependent on how fast the company is growing. X tends to increase (one-time) when the person gets promoted, shifts a job, takes up a new role, etc. The greatest advantage of earning income is that it gives a steadiness to the cash flow. Unless you do an epic screw-up, you know exactly what will be your incoming salary for at least 12 months, if not the next 3-4 years. That helps you plan your savings, expenses, investments, holidays, etc. Of course the disadvantage of this income is that its growth is capped at a certain level commensurate to how the industry & company is growing. Both the industry AND the company have to grow, else your salary growth is sub-optimal. At the early stages of an individual's career, earning this income consumes maximum time & effort and less time is spent on other types of income. 

• Portfolio income: As the individual starts growing in his career, his thoughts veer towards "additional sources of revenue". He wants to de-risk himself and be less dependent on circumstances (growth of industry, company, etc) to grow his own wealth. He also realizes that his savings tend to lie in the bank or FD giving sub-optimal returns and he starts looking at other options of investments. This leads him to explore ways of using his existing money (savings) to create more money. The portfolio income starts kicking-in when he starts using his money to make more money instead of using professional skills (as in a job). The most common portfolio income avenues in India are mutual funds, stocks and then the more exotic ones like derivatives. The advantage of portfolio income is that it de-leverages the individual from what is happening in his industry & company. It lets him tap into larger growth waves in different industries and to ride that wave to make money. It also brings a non-linearity to growth as he can seek growing stocks/mutual funds/etc instead of waiting for his industry to grow. The major disadvantage with portfolio income is that there is a steep learning curve before you start making serious money. So, it is time consuming and many times in tends to become a gamble rather than a planned investment. 

• Passive income: This income comes into play once the individual has worked for a few years and starts looking at acquiring "assets". Assets normally have a large upfront investment amount (Capex) and a steady revenue stream (monthly/quarterly/yearly incoming cash flow) while the value of the asset itself grows. Such assets could be investing in start-ups, investing in land/houses, etc. There has been a lot of debate in India whether houses are an asset with good returns or whether one should stay away from it - I will hold my comments on it for a subsequent post. The greatest advantage of the passive income is that it doesn't consume your time & effort after the initial investment. Still it keeps giving you a steady revenue AND the value of the underlying asset itself also keeps going up. The flip side to such investments is that they are illiquid in nature - meaning, it is much easier to sell a mutual fund as compared to a house or an investment in a company. 

Depending on an individual's financial maturity and aggression for growth these three types of incomes kick-in at different stages of his life. Once all the three start kicking-in, then, managing the portfolio for optimum growth becomes the next focus area.