How investors could aim for a £20k second income using the Warren Buffett method

Warren Buffett is perhaps the most successful stocks and shares investor ever. Who better to turn to to learn how to do it?

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When I look for ways to earn an extra income, I take inspiration from Warren Buffett. He’s been the leading light at Berkshire Hathaway since 1965, and he’s made a lot of money for a lot of people.

My other favourites include Ben Graham, Sir John Templeton, Peter Lynch, and more. They share one thing in common. And that’s buying top quality stocks at attractive prices, to hold for the long term.

Ben Graham, by the way, wrote The Intelligent Investor, which Buffett described as “the best book about investing ever written“. It’s a great read.

The alternatives

There are always other ways, mind. I might follow all those great investors who mastered the secrets of making millions from penny stocks.

Or I could learn from the experts at short-term stock market timing, and those who know how to find the next get-rich-quick multi-bagger.

I’m talking about people like… now… who is it?

Nope, can’t think of any. Long-term buy-and-hold for me it is, then.

Simplicity

No look at Warren Buffett would be complete without a quote. So, erm, here’s one from Peter Lynch:

Never invest in any idea you can’t illustrate with a crayon.

Peter Lynch

To explain something simply is perhaps the best way to actually understand it. With many stocks I look at, I can’t easily explain where future profits will come from.

But, say, house builders? They buy bricks, stick them on top of each other, and sell the resulting house for more than it cost to build. There, my crayon doesn’t even need sharpening.

Track record

Buffett has always bought companies with straightforward business models, which he can easily understand and explain.

He talks about them in his annual letters to shareholders. And those are another great source of wisdom that I’d recommend to any investor.

So what’s Warren Buffett’s net result?

Well, since that fateful day in 1965 when he became the boss, he’s achieved an average annual return of 20%. That’s massive.

A £20k income?

Just £100 invested back in 1965, left untouched and earning 20% per year, would have grown to £3.9m today!

Now, I don’t have 58 years left, and I don’t expect to make 20% per year. But in the past decade, Stocks and Shares ISAs have returned 9.6% per year on average. They do lose money some years, mind.

There are more than 4,000 ISA millionaires in the UK. And, judging by the top quality FTSE 100 stocks they buy — like Shell and GSK, which feature in a lot of millionaire portfolios — they have a lot in common with Buffett, thanks to their easy-to-understand business models.

They max out their annual allowance, which we can’t all afford to do. But what might a reasonable expectation be?

Compund growth

How about someone who can invest £10k per year? And manage a more modest 5% return?

It could take only 23 years to reach a pot big enough to generate £20k per year. They could have a sum of £425,000, and still only need 5% per year from it.

Investing in shares carries risk. But I reckon buying top FTSE 100 stocks and holding them for decades is the best way to minimise it.

And, oh go on then, here’s a Buffett quote to end on:

You only have to do a very few things right in your life so long as you don’t do too many things wrong.

Warren Buffett

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended GSK. 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. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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