Warren Buffett is often referred to as the world’s greatest investor. And given that his average annual investment returns stand at approximately 20%, I think it’s fair to say he’s earned that title. However, his strategy isn’t all that complicated. In fact, it can be summed up in one sentence – buy wonderful companies and hold them for the long run.
So, if I’m aiming for £1,000 each month in dividends, how can I use the Buffett method to achieve this goal? Let’s take a look.
Calculating the requirements
Despite the recent economic turmoil, the FTSE 100 is still on track to deliver a dividend yield of 4.1% this year. Investing in a low-cost index tracker could swiftly unlock this yield. But by carefully picking individual income stocks, boosting this to around 5% should be more than doable without jeopardising sustainability.
However, this quickly presents a bit of a problem. Even at a 5% dividend yield, I still need a sizeable amount of capital to reach my monthly income target — £240,000, to be precise. Needless to say, that’s not exactly pocket change. And that’s where the Warren Buffett method comes into play.
By consistently investing a small percentage of my salary each month, building a £240,000 portfolio isn’t as impossible as many may think. On average, the FTSE 100 generates an annual return of around 8%, including dividends. But once again, choosing to invest in individual high-quality stocks unlocks the potential for greater returns.
Even if my portfolio performance is only boosted by a couple of percentage points, it can make a big difference. For example, let’s say I’m able to spare £500 each month from my salary for investments. At an 8% annual return, I can theoretically hit my £240,000 target in just over 18 years. But if I can boost those returns to 12%, it would only take 15 years.
Of course, nothing is risk-free. 2022 has perfectly demonstrated how the stock market can be a volatile place. And future stock price corrections or even crashes, by nature, are inevitable. Depending on the timing of these unpleasant events, it could take considerably longer to hit my portfolio milestone. And if I’m not prudent in my stock selection process, I may end up destroying wealth rather than creating it.
Picking stocks like Warren Buffett
Warren Buffett’s stock-picking success comes from his ability to identify wonderful businesses. But what exactly makes a company ‘wonderful’?
According to Warren Buffett, the answer lies in competitive advantages. A firm that can consistently maintain an edge against its peers can end up becoming industry an titan in the long term.
Some common examples of competitive advantages include:
- A strong brand that commands pricing power.
- A unique operating method to boost efficiency and that’s not easily replicated.
- Switching costs that make it financially less viable for customers to switch to a competitor.
A company with multiple advantages over its competitor(s) is more likely to thrive. At least, that’s what I’ve seen. However, even industry leaders can sometimes be disrupted by external forces. So, there always remains an element of risk. But this can be partially mitigated through diversification. And in the long term, reaching my monthly dividend income goal should be obtainable.