When it comes to passive income, there are quite a few things I like about simply buying shares in proven companies. I can benefit from the work of blue-chip businesses and can invest as little (or as much) as my financial circumstances at that moment allow. When investing for passive income, I have learnt some things from billionaire Warren Buffett.
Buying into brilliant companies
Buffett looks for passive income in obvious places.
Most of his shareholdings are in large, well-known and long-established companies.
A lot of far less successful investors spend ages trying to find little-known firms they think could yet take the world by storm. Buffett, by contrast, is happy to buy shares in businesses that have already proven their business model and staying power over the course of decades.
Take his holding in Coca-Cola (NYSE: KO) as an example. Buffett started buying into the company back in 1987 and completed his stake-building in 1994.
When he started buying those shares, Coca-Cola had been listed on the New York Stock Exchange for 68 years. It had already raised its dividend annually for over two decades (and has continued to do so ever since Buffett invested).
So the Sage of Omaha was not looking for ‘the next big thing’. He was buying into an existing big thing. Today his company, Berkshire Hathaway, earns over $700m annually in Coca-Cola dividends. That is over half of what it paid in total for the entire stake.
With a large customer base, proprietary brands and strong pricing power, Coca-Cola is a classic Buffett pick. It faces risks, such as increasing concern about sugary drinks leading many consumers to prefer healthier alternatives. But, for now at least, the sweetest thing about Buffett’s long-term Coca-Cola stake is its incredible financial rewards.
Investing for the long term
Is it an accident that those rewards have built over the course of decades? No.
Warren Buffett is the epitome of a long-term investor. He says that if someone would not be willing to own a share for 10 years, they should not even consider owning it for 10 minutes.
Buffett’s Coca-Cola dividends have grown steadily for decades even though he has not added to his shareholding for 30 years.
As the old saying goes, over the long term, “quality in, quality out”.
Compounding dividends
Although Warren Buffett has not bought more Coca-Cola shares since 1994, he has not used the massive dividend streams to pay dividends to his own Berkshire shareholders.
Instead, like all of Berkshire’s earnings, he has retained them to use in other ways, from buying different shares to taking over whole businesses.
Reinvesting dividends is known as compounding.
From a passive income perspective, it has pros and cons. If I want passive income now, compounding my dividends might not be a good idea.
But if I am willing to forego some or all passive income from my portfolio now, compounding could be a smart way to try and build even bigger income streams in future – just like Warren Buffett!
