Image source: The Motley Fool
Warren Buffett doesn't seem like the type of person to sit at home thinking about how to earn passive income. After all, he is a billionaire many, many times over.
But Buffett has spent decades establishing passive income streams. In fact, he said: “If you don't find a way to make money while you sleep, you'll work until you die.”.
For Buffett, who often says how much he enjoys his job, that might be fine. However, for many people, making money while they sleep (another way of describing passive income) can help improve their lifestyle while they work, as well as in retirement.
Learning from Buffett's approach, this is how I propose to implement an investing approach today. I really think it could make me £1,900 in passive income every month in the future.
How Buffett Earns Passive Income
The 'Sage of Omaha' has earned large amounts of passive income by owning stakes in companies that have a proven technique to generate more cash than they need.
As an example, consider his participation in Coca Cola (NYSE: KO). The company operates in a field that is likely to benefit from long-term demand. Billions of people around the world need to drink something every day.
Thanks to a patented formula, an iconic brand and an extensive distribution system, Coca-Cola has a competitive advantage over its rivals. That helps you make more money than you need, which you can use to pay dividends. Coca-Cola's dividend has increased annually for more than half a century.
Buffett now earns more than half of what he paid for his Coca-Cola shares every year in passive income, in the form of dividends.
Learning from a teacher
That reflects a couple of important facts beyond simply picking a great stock to buy in the first place.
Buffett has owned the stock for decades. The long-term investing approach can help boost passive income over time if you invest in solid companies that regularly increase their dividends, as Coca-Cola has done (some cut or cancel them).
It also reflects the fact that purchase price matters. Buffett not only aims to buy large companies, but he tries to do so when his shares are available at an attractive price.
After all, the dividend yield of a stock reflects an objective element (what the dividend per share is) but also a subjective element (what price a specific investor paid for its shares).
Distributing the risks
Despite its performance, Coca-Cola is just one of the stocks Buffett owns. Even the best companies face risks such as ingredient inflation and changes in consumer tastes that could affect sales. That's why Buffett keeps his portfolio diversified.
Another critical element of its approach has been to reinvest its profits rather than pay them out as dividends.
Building income streams
Hopefully a similar approach of reinvesting dividends, known as compounding, can help me achieve my own long-term passive income goals.
For example, if you invested £100 each week in shares with an average annual dividend yield of 8% and reinvested those dividends, after 22 years you would be earning more than £1,900 each month, on average, in passive income.
An 8% yield is high, but some FTSE 100 stocks have one. So right now I'm looking for high-quality stocks with excellent income prospects.
