A quick Google search of the phrase ‘passive income’ returns a staggering 151m results. But there’s one definition that stands out.
It comes from fabled investor Warren Buffett. He said: “If you don’t find a way to make money while you sleep, you will work until you die.” It’s a quote that’s stuck with me.
Making passive income has become incredibly important over the last few years with racing inflation eating away at pockets. As such, I can see why investors are keen to start making some extra cash alongside their main source of income.
If I were starting today, here’s how I’d go about it.
Buying stocks
There are plenty of ways to make additional income. But arguably the simplest is buying shares that pay a high dividend yield.
I could start a side hustle or try and enter the property game. But I’m targeting companies that share profits with shareholders via dividend payments.
What constitutes a high yield is subjective. For me, I tend to largely target companies that pay a yield over 5%. For context, the FTSE 100 average is 3.9%.
Finding the right businesses
Investors also need to do their due diligence. While some yields may look attractive, they may not be sustainable. We saw this most recently with Vodafone’s 11.4% payout, which is now being halved in 2025.
I target businesses that operate in mature industries with proven business models and stable cash flows. Given that dividends are never guaranteed, a strong track record of paying investors is also key.
Let time do its thing
It’s taken investors like Buffett decades to build the large passive income streams they receive today. And there’s a lesson in that. Building these streams doesn’t happen overnight.
It’s a long-term process. Take his investment in Coca-Cola. He bought the stock back in 1988 and added to his position over a couple of decades. Last year, he received a dividend cheque worth more than $736m from the company.
Coupled with adopting a long-term approach, I’d use compounding. By reinvesting my dividends, I can earn interest on my interest. Over time, that can super-boost my wealth.
An example
That’s all well and good, but I’m not going to leave here without giving an example that ticks the above boxes. That’s where Legal & General (LSE: LGEN) enters the frame.
It’s an insurance and asset management company and a stalwart in its field. There are a few more reasons why I hold the stock. Let me briefly explain.
Firstly, it has an 8.6% yield. That’s comfortably above the 5% benchmark I look for. Secondly, it has increased its payout by 80.8% over the last decade.
Of course, like all investments, there will be volatility. Right now, the business is facing headwinds as high interest rates impact deposit levels. But given its position as an industry leader, it’s stocks like Legal & General I’d target.
£15,000 invested in the stock today with an 8.6% yield will give me an investment pot of £196,144 after 30 years, assuming I reinvest my dividends. By year 30, this would pay me £16,108 a year, or £1,342 a month, in passive income.
That’s a healthy amount of cash that would no doubt go a long way in allowing me to live a more comfortable retirement.
