When it comes to passive income, all sorts of people have ideas. But few have actually set up passive income streams of billions of dollars annually. Warren Buffett has.
That proven ability is one of the reasons I feel inspired by Buffett when it comes to earning passive income.
Another is that he has shared so much of his experience publicly, something I can learn from for free. I think it can be well worth paying to learn how to be a more successful investor – but some free ideas are welcome too!
So if I wanted to put Buffett’s views into action with the target of earning £1,890, on average, each month in passive income from share dividends, here is how I would go about it.
Focus on quality at the right price
One way some investors try and earn lots of income from shares is buying companies that offer a high dividend yield.
Sometimes that can pay off. But sometimes, a high yield can be a warning sign that a dividend is expected to fall – and then it does.
A recent FTSE 100 example is Vodafone. It announced this year that it plans to halve its annual dividend per share.
Buffett owns some high-yielding shares. But when choosing them, he has said he looks for a great business at an attractive price.
That strikes me as smarter than looking just at yield. After all, no dividend is ever guaranteed.
What I’d look for
In practice, what does that mean? Consider Unilever (LSE: ULVR) as an example. I reckon it demonstrates a lot of what Buffett looks for in an investment. In fact, he even tried to buy the whole company a few years back.
Unilever has a large potential customer market that is likely to endure. People will want to wash their clothes and shampoo their hair for the foreseeable future. It has built a stable of premium brands that sets it apart from rivals – and allows it to charge a higher price.
That helps the blue-chip company generate sizeable free cash flows to fund a quarterly dividend.
Will that last? One risk is that, in a tough economy, shoppers use supermarkets’ own brands rather than paying a premium for Surf or Dove.
Over the long run though, Unilever is the sort of company I think can help generate significant passive income. It has similar attributes to Buffett’s holdings, including Coca-Cola.
Aiming for an income target
How could that help me aim for a monthly passive income averaging £1,890? That is £22,680 a year. At the current Unilever dividend yield of 3.5%, that would require me to invest £648,000.
Could I start with less, much less? Investing in higher yield shares, without sacrificing quality of companies, could help me earn the same passive income while investing less.
So too could compounding my dividends initially instead of taking them out as cash. That is what Buffett does at his company Berkshire Hathaway. He reinvests gains.
For example, if I invested £1,000 a month at an average dividend yield of 7% and compounded those dividends, after 16 years, I would hit my passive income target of nearly £1,900 a month, on average.
