No savings? I’d use the Warren Buffett investing method to target a £7,000 second income

Warren Buffett’s investment in Coca-Cola hss been outstanding. Stephen Wright thinks investors should take a similar approach to build a second income.

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Image source: BP plc

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Excerpt: Warren Buffett’s investment in Coca-Cola has been outstanding. Stephen Wright thinks investors should take a similar approach to build a second income.

An investment portfolio that provides a second income can be a terrific asset. Earning extra cash can allow someone to do more, live better, or provide a more comfortable retirement.

It’s easy to think investing requires a lot of cash. But that’s a mistake – putting money aside regularly in the stock market can be a great way of earning substantial passive income.

Starting from zero

Having something to get started with does make investing easier. But even with no savings, investing part of a monthly salary in stocks that pay dividends can bring great results.

Investing £1,000 per month in stocks that offer a 5% dividend generates £325 in cash per year. Doing this for 10 years results in £3,250 in annual passive income. 

That’s good, but it’s possible to do a lot better. Reinvesting the returns each year at the same rate allows the investment to grow much faster.

Doing this for 10 years results in a portfolio generating £7,120 per year. That’s a meaningful second income, but the question is how to achieve a 5% annual return.  

Warren Buffett

One way of doing this is by looking for stocks that come with a 5% dividend yield. There’s nothing wrong with this, but it’s not the only approach available.

Warren Buffett has had a lot of success by buying shares in companies that can grow over time. Coca-Cola is a great example.

Back in 1994, Buffett’s 400m shares in Coca-Cola generated $75m in cash income. Since then, the dividend has increased to the point that Buffett’s stake returns $732m per year.

Buffett’s strategy of investing in companies that can grow their earnings is instructive. To average 5% over a decade, a stock doesn’t have to come with a 5% dividend yield today.

Where to start?

If I were getting started today, I’d think about buying shares in FTSE 100 oil major BP (LSE:BP). The stock currently comes with an attractive 4.7% dividend yield. 

The biggest challenge for the company is the ongoing transition to renewables. While I think this is going to take longer than most analysts are expecting, there’s a clear risk here.

BP has made mistakes when it comes to investing in renewables. But I think these are causing the market to underestimate its future cash flows, creating an opportunity. 

With a new CEO and a focus on shareholder returns, the company seems to be on the right track. I think the future dividends can average 5% per year over the next decade.

Dividend income

Shares in companies that distribute their profits as dividends can be a great source of extra income. And it’s possible to get started without having huge savings. 

A 5% annual return and reinvesting dividends for 10 years is enough to turn a £1,000 monthly investment into a second income of £7,120 per year. And I think this is achievable.

Warren Buffett has been investing steadily in Occidental Petroleum – a US oil company – recently. I think BP also fits the bill, though, and it’s the stock I’d buy to start 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.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Occidental Petroleum. 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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