Turn £8,900 into a £24k annual passive income? Here’s how!

Christopher Ruane applies some investing lessons from billionaire Warren Buffett when explaining how he’d aim to earn sizeable passive income streams.

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Warren Buffett at a Berkshire Hathaway AGM

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One way of earning passive income that I think has a lot going for it is buying shares in proven companies that pay dividends to shareholders.

Now that really is passive – and can be lucrative.

If I had a little under £9,000 to spare, here is how I would use it to try and earn £2,000 a month on average in passive income over the long run. That is £24,000 a year!

Learning from a billionaire investor

Not all shares pay dividends, even if they have before. My plan involves dividends, but also share price gain.

That is the approach taken by legendary investor Warren Buffett. He has made billions of dollars in the stock market, from a combination of dividends and growth in the value of the shares owned.

Even the best investors can be blindsided by unexpected events. Like Buffett, I would therefore focus on buying only what I thought were the highest-quality shares.

Again, like him, I would diversify. £8,900 would let me spread my passive income portfolio across multiple companies.

Finding shares to buy

What sort of companies would I look for? Once more, I think Buffett has some inspiration for me!

Take his stake in Coca-Cola (NYSE: KO). The soft drinks producer has become a passive income gusher for Buffett. He revealed last year that his firm was now earning 54% of the cost of its Coke shares every year in passive income from them.

That reflects Buffett’s long-term approach to investing. He has held Coke for decades.

But it also reflects smart share picking. When he started investing in Coca-Cola, it was already a large, well-established blue-chip company with a proven business model.

Competitive advantages such as a proprietary formula and famous brand helped it generate free cash flows to pay dividends. Indeed, it is a Dividend Aristocrat that has raised its dividend annually for over six decades.

It faced risks when Buffett bought the shares as it does now, such as health concerns about sugary drinks hurting sales. But Buffett’s holding is still worth far more than he paid for it, because he bought the shares at a good price when weighing potential rewards and risks.

Aiming for long-term growth

My passive income plan should benefit from a long-term approach to investing. But that also means I need to be patient before earning without working.

Imagine I could grow the value of my portfolio by 15% a year, through a combination of share price growth and reinvesting dividends like Buffett does.

That is ambitious, though it is significantly lower than Buffett’s long-term annual returns – and he reckons he could perform better if investing small amounts than he has at his disposal.

Doing so, after 23 years I would have a portfolio worth around £274,000.

To hit my target, at that point I could focus on dividends not share price growth. Investing the money at an 8.8% average dividend yield, I would hit my goal of a £24k annual passive income.

That 8.8% is high, but currently quite a few FTSE 100 companies offer such a percentage.

Putting the plan into action

There is no time like the present. So my first, practical, step in aiming to build these passive income streams would be to open a Stocks and Shares ISA. Today!

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.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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