When it comes to passive income, we can all learn a thing or two from Warren Buffett.
The billionaire investor earns millions of dollars every week on average in passive income. How does he do it? Simple: dividends from companies whose shares he owns.
That approach does not require large amounts of money. Here is how I would put the Buffett approach to work if I wanted to try and earn money without working for it.
Some companies pay big dividends
While some businesses do not pay any dividends, others have small ones as a percentage of their current share price (what is known as the dividend yield) and some pay a large yield.
Take Phoenix (LSE: PHNX) as an example.
With a dividend yield of just over 10%, buying its shares could mean that I get £10 of passive income per year in future for each £100 I put into Phoenix shares now.
But in reality things may be more complicated. Dividends are never guaranteed, so the current yield of any company does not necessarily give me an indication of what I will actually earn from it in future.
How to hunt for dividends
So, how has Warren Buffett managed to build such sizeable passive income streams?
Of course the amount he is investing and the long timeframe of his stock market career both help. But a critical factor has been his approach to finding companies in which to invest. He looks for industries he expects to benefit from strong future customer demand.
Within them he looks for firms that have some sort of competitive advantage he reckons can help them do well in future.
Whether or not Phoenix is up Buffett’s street I do not know. He does not own shares in it.
But financial services and specifically insurance have long been favourite investment areas for him.
With a large customer base of insurance and pensions clients, I expect Phoenix could do well in future. It can benefit from owning well-known brands, including Standard Life.
Then again, the company faces risks. For example, its book of mortgages involves certain assumptions about property prices. If they tumble unexpectedly, that could hurt profits at Phoenix – and my passive income expectations if I buy its shares.
Taking a smart approach to investment
Like Warren Buffett, therefore, I always keep my portfolio diversified across a range of companies.
If I make the right choices, hopefully I could benefit as successful companies with large customer demand generate significant cash flows in years to come and pay them out as dividends.
My first move would be setting up a share-dealing account or Stocks and Shares ISA today.
I would then put some money into it, or start drip-feeding some cash regularly. At that point I would start my search for passive income superstar shares, using some of what I have learned from Warren Buffett.
