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Investing in the stock market can be a great source of passive income. But finding quality stocks with attractive dividend yields can be challenging right now.
So what can I do? Should I accept lower returns from quality companies or seek higher returns on riskier investments?
high yields
According to Warren Buffett, the answer is simple:
If you need to get 3% and you only get 1%, the answer is to stop giving 3%. It is not to take the one to the three and do more dangerous things. You should always adapt your consumption to your income; You should not try to match your income to your consumption.
In other words, Buffett believes that taking greater risks by seeking higher-yielding stocks is dangerous. I agree: if the company cuts its dividend, the share price is likely to fall with it.
A good example of this is Hargreaves Lansdown. The stock has a dividend yield of over 4%, but I think it looks risky.
The company pays out almost all of its net income as dividends. By itself, I don’t think it’s a problem, but his earnings have been falling.
If the dividend is cut, then I think the stock price is likely to fall. This illustrates the danger of seeking higher returns in riskier ventures.
quality business
So what should I do instead? Buffett has the following advice:
People say ‘well I’ve saved all this money my whole life and now I can only get 1%, what do I do?’ The answer is that you learn to live with the 1%, unfortunately. And you don’t go and hear a salesperson come up and say ‘I have a magic way to get you 5%’.
I think what Buffett has in mind here is illustrated by right movement. The stock currently has a dividend yield of 1.37%, which is not flashy.
Rightmove shares look like a much longer lasting investment to me than Hargreaves Lansdown. And that’s important when it comes to passive income.
The company distributes just under 35% of its earnings as dividends, and those earnings are growing. Rightmove also increases its shareholder returns through share buybacks.
dividends
Warren Buffett’s advice when it comes to passive income is clear. It is much better to accept a lower return from a quality business than to seek a higher return from a riskier stock.
Even with the best deals, dividend payments are never guaranteed. There is always a risk that Rightmove management decides to suspend their dividend, as they did in 2020.
The point is, however, that the company was not forced to do this. And since then, the dividend has been restored to a higher level than before it was cut.
I take Warren Buffett’s advice when it comes to passive income and stick to long-lasting businesses. Even if the returns being offered today are lower, I think I’ll do better this way over time.
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