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There are numerous ideas online on how to generate passive income. They range from vending machines to audiobook recordings. However, while many of these seem interesting, I prefer to stick to the proven example of wealth creation set by Warren Buffett.
a lot of effort
Nowadays, dropshipping is one of the most popular ideas. This is an order fulfillment method that does not require a company to stock its own products.
Instead, it sells the items online and passes sales orders to third-party suppliers, who then ship the orders to the customer. The seller takes a cut without dealing with stock, which at first glance seems great to me.
However, there also seems to be a lot of work involved. There are operating costs for marketing and advertising, site maintenance, and ongoing search engine optimization (SEO) needs.
Furthermore, due to fierce competition, there seems to be a lot of price undercutting. Consequently, dropshipping margins are usually very low.
So this seems like a time-consuming task to me rather than a passive, effortless income stream. As far as I know, the juice is not worth the squeeze.
Invest for dividends
On the contrary, the money I get from dividend stocks is totally undeserved. Assuming nothing causes the company to reduce my payout, which is always a risk, I receive money simply for being a shareholder.
While I can spend this passive income as I see fit, I prefer to reinvest my dividends to buy other stocks. These can earn me even more dividends in the future, and so on.
This takes advantage of what Albert Einstein is supposed to have called the “The eighth wonder of the world“. That's compound interest, and Warren Buffett's $100 billion-plus net worth is the ultimate embodiment of his power.
<h2 class="wp-block-heading" id="h-finding-stocks-with-moats”>Finding stocks with Moats
Buffett likes to invest in companies that have what he calls an “economic moat.” Like around a medieval castle, a moat prevents competitors from encroaching and stealing market share.
The most obvious example is the brand moat. Companies that have very strong brands often enjoy customer loyalty, which makes it very difficult for new entrants to enter. They also have pricing power to preserve profit margins.
Two examples would be Coca Cola and McDonald's. Coke has increased its annual dividend for 61 consecutive years, McDonald's for 47 years.
These are the type of dividend stocks I would like to build a portfolio around.
Generating passive income
Buffett's investment history since taking office Berkshire Hathaway in 1965 is truly extraordinary. It has obtained an average return of 19.8% annually, double the market average.
It has done so by taking a long-term view. The volatility of the stock market does not scare you and you stop investing, which means you have all the time necessary to grow in value.
To move towards great passive income, I will also have to take a long-term investment view.
Finally, the good news is that I don't have to replicate Buffett's incredible track record to earn an impressive sum. An 11% annualized return on £500 a month would take me to £404,638 after 20 years.
With this, I could earn £32,371 in annual passive income if my portfolio collectively returned 8%.
