Warren Buffett is probably the most famous investor around. I credit a lot of my investing knowledge to the advice he’s given over his long and successful career. One of his famous quotes really struck a chord with me: “If you don’t find a way to make money while you sleep, you will work until you die.”
Something clicked for me when I first heard this. It made me think that I should really focus on long-term investing as it’s a great way to make my money work, all year round. Then, when the dividends start rolling in, I’m on my way to generating passive income.
There are many ways to focus on long-term investing. I’m going to explore some Warren Buffett methods here with passive income in mind.
Warren Buffett and passive investing
Even though Buffett himself is an active investor – buying and selling stocks directly – he’s also an advocate for index funds. This is when an investor buys shares of a fund that aims to replicate the performance of a stock index, like the FTSE 100. Buffett said in his annual shareholder letter in 2016: “Both large and small investors should stick with low-cost index funds.”
Often, this strategy is referred to as passive investing because I’d simply track the performance of a stock index. I use this technique in my own portfolio. The fees for index funds are typically low (just like Buffett suggests). Furthermore, an index fund is diversified with many stocks, so the risk is generally lower. There’s always a chance of a stock market crash though, so my initial investment could fall in value.
I’ve set up a direct debit to put money into my ISA each month to buy one particular stock — iShares FTSE UK Dividend Plus, an exchange traded fund (ETF). Of course, the returns from a tracker may be less spectacular than from some individual stocks. But the current 12-month dividend yield is 5.7%. A yield this high can really help towards my passive income goal. The fee is low at 0.4% annually, and my broker lets me buy at zero dealing cost.
Increasing risk and reward
But overall, he certainly isn’t a passive investor. He’s had an illustrious career by investing in companies he knows well, and then holding them for very long periods (often decades). A private investor like me can do that too, as long as I research every company thoroughly before I buy its shares.
I have to remember that buying single stocks is riskier than investing in an index fund. Price volatility is typically higher, and I’d be less diversified. Nevertheless, the potential returns are higher to compensate for this increased risk.
In addition to my index fund, I buy high-yielding dividend stocks to increase my passive income. I own shares of Legal & General and British American Tobacco, two companies with yields of 6.5%+. Rio Tinto is another stock I buy as it currently offers a dividend yield of 8.8%.
Together with my index fund, buying single stocks has seen me generate a growing passive income stream over the years. Now, my money does work while I sleep, as Warren Buffett advised. I’m taking a long-term view from here and adding to my investments so that my passive income keeps growing.
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Dan Appleby owns shares of Legal & General, British American Tobacco, Rio Tinto and iShares FTSE Dividend Plus. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
