What Is Residual Income?

Residual income is a type of passive, and so-called disposable income. Beyond this, however, the definition becomes complicated, depending on where that money is coming from, what you plan on doing with it, and what it means to you, either as an individual or as an enterprise. Here are the three main ways to define residual income.

Residual income in personal finance

In personal finance, residual income is all the money an individual is left with at the end of a payment cycle, after all the outstanding bills and debts have been handled, including utility bills, mortgage payments, credit cards, etc. For a clear illustration, check out the short Investopedia video below:

http://www.investopedia.com/terms/r/residualincome.asp

As the video explains, residual income may be relevant for securing loans. Some lenders will want to assess your RI standing, to make sure you have enough money to pay off your loan in full each month.

Residual income for entrepreneurs

In business and money-making, residual income is money you continue to receive regularly, after making an initial sale/lease/other type of transaction. In other words, you create a long-term self-renewing source of income, then sit back and let the money come at you.

The best illustration for this principle is a residential property investment: you renovate a multi-family residence, then collect rent every month. Royalties from creative works (books, films, music recordings) are also a form of residual income. Finally, entrepreneurship comes with a host of residual income-generating opportunities. Say you take after Richard Branson, create 400 companies assign a CEO to each, then let the dollars roll in. Or you create a co-op with professionals in your field, who leverage their results by compensating you for your initial investment in them. Finally, the online world is chockfull of residual income opportunities—but more on that in a separate section below.

Residual income for enterprise valuation

Finally, in the world of finance, residual income is a method for valuating a company, based on the net income it has left, once it has paid out equity charges to its shareholders, to compensate for their investment risk. To understand this absolute valuation method, check out the formulas below. Though they don’t directly fall under the scope of our endeavors, it’s important to understand that residual income can be a powerful asset in the eyes of potential investors into a business enterprise.

Residual income for money-making: The difference between passive and residual income

One of the most frequently encountered errors, when it comes to understanding residual income, is mistaking it for passive income. The two terms may seem interchangeable, but they most certainly are not, when it comes to generating income. Aside from the realm of personal finance, which has been addressed above, in business, both these types of income refer to money that you make without having to put in any efforts at present. However, there’s a subtle difference between the two. Subtle as it may be, it’s essential to understand it, before delving into the subtleties of making money online. To get a good grasp of it, check out the two definitions below.

Passive income definition

Passive income is the income you derive from any type of investment in which you are not currently actively involved. In plain English, money you make without putting in any effort right now (though there may have been some effort involved in the initial stages of the investment).

Residual income definition

Residual income is income you typically receive in (regularly) recurring payments, after having made an initial sale, or other type of investment. This is money that typically comes in fixed amounts, at fixed intervals.

So, in a nutshell, most forms of residual income are also passive income, because getting the money doesn’t require you to make any further efforts. However, there are types of passive income which are not residual, i.e. which don’t come in at regular intervals and/or in fixed amounts.

Residual income for businesses: The residual income model

As explained by Wikipedia, RIM (residual income model), also referred to as RIV (residual income valuation), is one of the many methods of calculating the actual value of a company. There are numerous approaches to the issue of enterprise valuation—some take a relative approach, while others, like the RIM, are absolute. Relative valuation entails looking at the various metrics of a company and then comparing its standing to that of others in the same industry or market sector. And then, there are absolute valuation methods, like DDM (dividend discount model), DCF (discounted cashflow), and, of course, RIM.

It’s important to understand that residual income doesn’t have the same meaning for equity valuation as it does for personal finance. That’s because it doesn’t entail leftover cash, or so-called disposable income, but it has to do with the income that a company generates, after accounting for capital costs, according either to CAPM (Capital Asset Pricing Model), or APT (Arbitrage Pricing Theory). In other words, residual income valuation is the money the company is likely to be left with, once it covers opportunity costs (or risk costs), relative to the book value of Shareholders’ equity. Bear in mind that firms have no legal obligation to compensate shareholders, like they do for bondholders. However, without this form of compensation for the risk they’re taking with their investment, it’s unlikely they will attract investors. Here’s all of the above, laid out in a plain math formula:

residual income = net income – equity charge

So, then, how is equity charge calculated? By simply multiplying the equity capital which the company has at its disposal, with the necessary rate of return for said equity. According to te CAPM, this is how the formula looks:

equity charge = equity capital x cost of equity

Residual income valuation formula

The above seems simple enough, but it’s pointless if it’s not put to work toward calculating the actual intrinsic value of the company. And since the residual income valuation formula is an absolute approach to company valuation, it discounts future earnings to get to the fair value of company stock. To calculate the value of the stock, one has to add the book value and the present value of expected future residual income, discounting the cost of equity (illustrated in the first formula below with the symbol . For the purposes of valuation calculation with formula 1, the company will presumably continue to evolve toward maturity, or constant growth. Formula 2 below is for calculating Terminal value. Constant growth () from year is presupposed, according to the PGM (Perpetuity Growth model).

Residual Income FormulaImage source: Wikpedia.org

Finally, the equation which represents Formula 3 in the image above leads us to the valuation of residual income. It’s worth mentioning that, in spite of similarities between this model and DDM and DCG, this model is the most appropriate for companies who don’t pay dividends, or who have a track record of several years of negative cash flows, but are expected to shift to the positive in the future.

VA residual income chart

As explained in the Investopedia video above, residual income may play an important part in successful loan applications. In fact, some of the safest loans on the market come with this approach to debtors’ income. One such type of loan are VA mortgages. These highly affordable loans frequently require no down payment (in the case of about 80% of such products on the market right now), yet they’ve also seen one of the historically lowest rates of foreclosure over the past 10 years. Some experts claim this is because of their residual income standard, which aims to make sure that veterans can afford monthly payments on their home loans. The amount of residual income required, in order to be eligible for a mortgage of at least $80,000 varies based on where you live, as detailed in the chart below:

Regional Residual Income Table

Image source: VeteransUnited.com

Loans for service members currently on active duty entail similar residual income standards, but these are typically lower by some 5%. Furthermore, if you have any dependents (children, parents, spouses), who are financially self-reliant and can make proof of their sources of net income they earn (like jobs or other ways of making a living), which could offset their own debt, you can write them off your RI standard list.

Bear in mind that, like debt-to-income ratio, RI is a non-negotiable criterion for exclusion from the application process. In other words, if you don’t meet the RI standards for your area, you won’t necessarily be denied the loan—but you do stand a high chance at having your application rejected. Furthermore, DTI and RI are in direct correlation. If your DTI is 41% or higher, your RI requirement would be 20% higher. You should always check out a mortgage calculator (there’s plenty of good ones online), before applying for any type of mortgage—even a safe one, as VA mortgages usually are.

Residual income ideas for the contemporary investor

Jim Rohn Quote About Investing

Image source: AZQuotes.com

Rohn was a successful entrepreneur and motivational speaker who, after having founded several successful direct marketing companies, went on to hold speeches and mentor other like-minded people in business. Most famously, he trained Herbalife International founder Mark R. Hughes—and the rest of that MLM success story is history. The rest of the quote goes, “(…) But it won’t be long before I’m working full-time on my fortune. Can you imagine what my life will look like?” The takeaway here is that careers are slow to build, require massive time investments, and, in the long run don’t mean you’ll have too much to retire on—if you only rely on them. So, then, what are some sound ways of building residual income these days?

The above question, pressing and frequently encountered as it may be, is by no means easy to answer. With the global economy still reeling after the most recent recession, the slowdown of Asia’s economic powerhouses, and the Eurozone crisis, present-day investors are hungrily looking for safer income generation opportunities. Both the real estate market and the stock market are still seen as high-risk and while a select few may be generating massive returns, their outlook for the beginner investor is not exactly rock-solid or rosy. How, then, can one make money nowadays? In the following, we explore several opportunities for making money online with little to no effort, outline an approach to this kind of income generation technique, and also offer you a glimpse into our own process.

So, then, is there easy money to be made online? Though the days of the dotcom bubble are far behind us, there’s still plenty of prime property and ample room for creative, ingenuous money-making online. Check out our top picks:

  • When you create a website, you can become an affiliate of several major e-commerce platforms, the most popular of which is, of course, Amazon. Your affiliation partner pays you a monthly commission, based on the number of referrals you’ve generated from your site (trackable via a code). Their behavior on the affiliate partner’s site is also relevant, i.e. purchases obviously matter more than simple clicks on affiliate links.

A visual outline of becoming an Amazon Associate affiliate partner

Becoming an Amazon Associate Affiliate Partner

Image source: TheIMRunner.com

  • Renewable subscriptions. Most of the tools and resources we use, in order to manage our online projects, are subscription based. These range from domain hosting providers, to task management solutions, to SEO (search engine optimization tools). Our providers generate residual income each month, by cashing into the renewable subscriptions purchased by their clients. However, this subscription payment model has been successfully used in all sorts of segments of the e-commerce industry, from cosmetics (subscription-based sample boxes) to food (home-deliverable monthly gourmet baskets). The initial investment of creating a functional e-commerce platform can run high, but with appropriate leverage, it can rake in major money.

Monthly subscription pricing plan tiers from SEMRush

Monthly Subscription for SEMRush

Image source: SEMRush.com

  • Online network marketing. Offline multi-level marketing (or MLM, in brief) is a successful business model, as evidenced by established companies like Amway, Herbalife, or Avon. On the downside, it can also be a scamming tool, as illustrated by the ACN dupe more recently, and plenty of others further back in time. On the legit side of the debate, in the day and age of digital media, this model can be successfully implemented online as well. It requires a powerful presence as a personal brand and key influencer, as well as a solid list of newsletter subscribers. And while the jury is still out on the ultimate efficiency of MLM, it’s worth a shot, if you’re more of a social networking kind of business person.
  • Money-making websites. Finally, in an income generating strategy that has the ‘property’ aspect in common with real estate investment, you can choose to create a website that basically makes money for you, while you leverage the assets of others (time, content creation abilities, link building, and income generation). More on this process and the four stages of its deployment follows below.

The 4-stage process of creating a residual income-generating website

Stage #1: Identifying profitable niches

There’s no single approach to doing this right, nor have any of the many SEO ‘gurus’ out there come up with a sure-fire approach to determining what works and what doesn’t, in terms of niche profitability. But if you’re thinking of creating your own money-making website, here are a few pointers and guidelines to get you started:

  • Think of yourself. What are your interests, passions, and hobbies? What is the one field to which you could contribute with added value? Think of this as your UVP (Unique Value Propositions), formulated in terms of “I could be the number one resource on (…)”. Insert your field of choice at the end of that proposition, then try to make it as narrow as possible.
  • Think of the money. Of course, not all niches, no matter how specialized, are profitable. Some don’t have that powerful of an industry attached to them. Others are simply too scientific, academic, esoteric, or, conversely, over-exploited. To get a feel of the niches you’ve narrowed your list down to, you have several types of tools at your disposal:
    • Advertising tools. Check out Google’s AdWords Keyword Tool and plug in some of the keywords that describe your niche(s) of choice. If their average CPC is more often than not over $1, chances are there might be some money to this endeavor—especially if some are over $5. Make sure to also have a look at the competition, to see how easy it would be to rank for those keywords. Pro tip: the higher the competition, the lower your odds.
    • Research tools. Continuing along those same lines, you should take a more in-depth look at keyword ranking difficulty. If your niche of choice is particularly well-populated, take a good look at who your main competitors would be. Pro tip: A keyword for which the top 10 ranking domains are high authority websites is a lost bet right from the get-go.
    • Affiliation programs. Finally, head on down to Amazon, ClickBank, or CJ.com and look for products that match your niche. The better the match, the higher your odds at monetizing through an affiliation program.

Stage #2: Creating a website

For this stage, you’re going to need a couple of tools and resources, as outlined below. Bear in mind that building a website in WordPress costs next to nothing these days—however, on the downside, building a mediocre, or spammy-looking website could nip your project in the bud. This is why we recommend working with a digital content agency from this stage onward. After all, if you’re still investing time and energy into this kind of project, it no longer passes as residual income, since you’re actively working on it. Typically, a good content agency will handle all your needs, from domain hosting, to coding, and content creation. Here’s the checklist for what this step requires:

  • Domain hosting. One of the cheapest available hosting solutions out there is HostGator, which also supports WordPress websites. However, bear in mind that their hosting capacities are limited and perhaps better suited for (very) small personal websites. For a more professional approach, look into investing into a more expensive host.
  • Domain name purchase. Most often, domain names will be purchased from GoDaddy. Expect to pay anywhere from a few dozen to a few hundred dollars, depending on the scope of your project.
  • Website creation. As explained above, such projects are best implemented on WordPress, which hosts some 60% of all the world’s websites as of this writing. Not only is the process simple enough and the platform versatile, but the wide range of (customizable and affordable) templates out there make WordPress a perfect solution for very diverse types of websites.
  • Analytics tool. You will, of course, want to install Google Analytics on your websites—but that’s just scratching at the surface. Heatmaps, click maps, SERPs, and other more sophisticated stats will all be essential from generating revenue from your website, as detailed in the description of the following stage.

Stage #3: Generating content

In what is perhaps the most delicate stage of the process, we advise all those who do not have a serious passion for writing to call on the services of a serious content generation agency. And even those who do like writing will find that such SEO projects take more than a mastery of the intricacies of the English language and a way with words. To understand how the process works, here’s a cursory sketch:

  • Generating titles, based on keyword research with specialized SEO tools.
  • Organizing titles based on categories and grouping articles based on keyword difficulty.
  • Writing several ‘power pages’ for popular keywords, interlinked with shorter ‘supporting pages’.
  • Optimizing each article for long tail keywords relevant to your niche, as well as for metadata, unique words, and more.

Stage #4: Monetizing the website

Finally, you have the option to add one or several of the following income streams to your website. Bear in mind that Google frowns upon websites which monetize from more than one source.

  • AdSense ads. Likely requires little to no introduction. In terms of how much money you can make, one freelance money-making website builder has managed to generate roughly $100,000 per annum from her 10 niche websites thus far.
  • Affiliate links. A good deal with Amazon is one that pays at least $75 to $100 per month, with seasonal holiday boosts. Also consider looking into other affiliations as an alternative, such as those offered by Commission Junction (CJ.com).
  • Google wants all sponsored content to be clearly marked, so make sure you do so, when working with sponsors. To monetize from this source, your website needs to have accrued some visibility and/or social traction.
  • Product sales. You can also add a Shop section to your website, where you can sell just about any type of e-product. These include e-books, guides, videos, webinars and other types of courses, downloadable designs, and more. It pays off to produce content, both on-site and off-, to market these products.

 

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