Passive income is income we don’t have to work regularly for, like in our day jobs. It does usually entail a bit of effort up front, though. And there are many ideas for generating long-term passive income out there — ranging from perfectly feasible ones to some that are barking mad.
Most of the ideas I unearth seem a little fanciful to me. And spending £20 a week on a few beers certainly isn’t going to do it for me — tempting though it is. I reckon the best way to invest is in shares on the UK stock market. UK shares have, after all, beaten other forms of investment hands down for more than a century now.
The best shares
But how do I pick the best shares to buy? A lot of newcomers to stock market investing make one simple mistake. They search for ‘the next big thing’. They dwell on shares that have rocketed over short timescales in the past and have made investors a fortune. They imagine that they’re going to discover the next one.
But very few dreamers end up with a healthy passive income that way. The high-risk shares they tend to chase often have an unfortunate habit of crashing and burning.
It’s certainly not the approach of the world’s most successful investors. Take billionaire Warren Buffett as an example. Under his guidance, investing company Berkshire Hathaway has returned an average of 20% a year since 1965. That could work some magic on my £20.
How to do it
How would I invest like Buffett? His annual letters to Berkshire Hathaway shareholders can be a mine of educational information. And in his 1996 letter, he offered the following guidance…
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
For me, that means companies providing essential good and services, and not fashionable new ideas. And it means companies generating lots of cash and paying big dividends, rather than jam-tomorrow technology startups with no profits yet.
I’d buy shares in supermarkets rather than cybersecurity startups. And I’d buy brewers and distillers rather than cryptocurrency firms. Instead of blowing £20 a week on booze, I’d invest in companies that make it.
Enough money?
Would my modest £20 really be able to generate any kind of nest egg? Well, I’d start small like that. And then at times when I could afford to, I’d increase my regular savings a little. And dividends I get from the shares I buy would go straight back into the pot.
Starting investing in shares with modest regular sums is a great first step. But the real secret of compound returns is to reinvest all dividends in new shares, and keep doing it for decades.
A lot of people end up with tidy sums that way when they retire. And their decades-long investment habits often provide them with healthy passive income streams.