What It Means to Diversify Your Income and How to Do It

Diversify your income for financial freedom

Uber driver with passengers in the back seat
•••

 Getty Images / LPETTET

There's always a chance that you could lose your job, no matter how long you've been with your employer or where you are in your career. Whether it's because of industry changes, market downturns, COVID-19, or a spat with your boss, the impact can be severe. One way to protect yourself is by diversifying your sources of income.

Key Takeaways

  • Diversifying your income means drawing earnings from two or more sources rather than from just one job.
  • A diversified income can protect you against the loss of your sole job. It can help you to save or invest more for your future.
  • The internet abounds with side-hustle opportunities, including online stores and content writing.
  • How much time you have and how long you want to commit to extra hours should dictate the nature of your extra sources of income.

What Does It Mean to Diversify Income?

A diversified income derives from more than one source. A diversified portfolio is one that has investments spread across assets such as equities, fixed income, commodities, and cash, and is recommended to limit risk. It also spreads out the holdings within each asset class.

The same concept of spreading your exposure can apply to the ways you earn money, even while you're holding down a full-time job.

Benefits of Diversifying Your Income

Angela Moore, a Certified Financial Planner, is the founder of Modern Money Advisor, a fee-only financial planning firm. "Diversifying your income can help provide stability. It can hedge against income loss due to layoffs, illness, disability, discrimination, and more,” Moore said in an email interview with The Balance. “Having multiple streams of income can have an incredible impact on your ability to build wealth and/or fund retirement." 

Recent events would certainly support that advice. Almost 30% of U.S. workers either lost their jobs or took a pay cut by May 2020 because of the COVID-19 pandemic, according to the Pew Research Center. The National Bureau of Economic Research (NBER), which monitors the economy and its health, made it official in June 2020: The country had entered a recession in February.

Diversification in a Recession

Creating more than one stream of income can be a path to financial independence beyond providing some "income insurance" if you lose your primary job. "Looking for multiple sources of income is a prototypical millionaire-next-door type of behavior," according to Sarah Stanley Fallaw, co-author of “The Next Millionaire Next Door.

The dividends and interest from an investment portfolio, rental income, and a part-time side job are all ways to diversify your income.

Active and Passive Income

Income falls into two classes: active or passive. Active income is that which is earned from a job with an employer, or from running your own business. Passive income can come from rental property, royalties, or investment income. You don't have to work on the clock to earn it. It pays you even while you sleep.

Diversifying by earning extra active income means making a time commitment. Side hustles like driving for a ride-sharing company, pet sitting, or consulting all demand that you labor in your off hours to add to your primary paycheck.

But you can pursue you full-time line of work while earning money at the same time if you diversify with passive income. Building passive income can involve a large amount of time and money at first. Rental income is passive, but you must first buy a property and pay for ongoing maintenance. You'll have to invest some time into managing it.

Not everyone has the financial resources or time to invest in real estate or to derive income from a portfolio.

What You Can Do to Diversify

Web-based businesses are a low-cost way to build passive income. Creating your own website can generate passive income from advertising, referral fees, and the sale of products or services. Platforms like Shopify make it easy and affordable for anyone to create and manage an online store. The big investment is the time it will take to research and build a plan. 

Helen Buttery leads special operations for American Writers & Artists Institute (AWAI), a company that helps develop content writing and online business-building skills. "Web-based businesses can be a great source of supplemental income. You can create the site at home. Let it work while you are employed or working on other projects. The site can be on any topic, so you can pick subject matter that matches your interests,” she said in an email interview with The Balance.

“The key to success is matching your interests with a large enough internet audience and making it easy for them to find you," she said.

Drawbacks of Income Diversification

One of the few constants in life is that there are only 24 hours in a day. You'll have less free time for other things if you take on a part-time job, such as being a ride-share or food-delivery driver. It also doesn’t pay to diversify your income if the effort costs you your full-time job and you need that income to survive. Make sure the added demands of your passive business activities don’t affect your job performance or endanger your health. 

Consult with a professional advisor to avoid placing yourself in financial peril if you have the resources to invest in real estate or become a silent partner in a business, but not the expertise or time to research prospects.

The economy can have an impact on secondary income streams, especially with investments in businesses and rental properties. It's hard to know yet what the impact of COVID-19 will be on commercial office space and brick-and-mortar retail locations. But consumers have increased online purchasing across many categories, according to an April 2020 article by consulting firm McKinsey & Co. They may continue to do so after the pandemic.

This opens up further opportunities for starting an e-commerce business. 

The Bottom Line

Passive income can work for you while you sleep, and it might be a source for building wealth. A diversified income can provide some protection against losing your main job or other economic downturns.

Diversifying by adding active income, like driving for a ride-share company or taking on a "side hustle," is a way to pay off debt or save money. But it means making a time commitment. Investing in the financial markets, owning rental property, or creating a web-based business provide chances to build passive income, but be sure to do your research.

Don’t let your side-income streams put your full-time job at risk unless you can survive without it.