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I’d follow Warren Buffett’s tips to retire on a growing passive income

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Mirroring Warren Buffett’s insistence on purchasing high-quality companies could allow an investor to generate a larger passive income in retirement. Such companies may offer more impressive profit growth and higher returns than their peers in the long run.

Furthermore, adopting his long-term focus may mean that compounding has a longer timeframe through which to positively impact on the value of a retirement portfolio.

Meanwhile, his insistence on having cash savings at all times may mean it is easier to purchase undervalued shares in a stock market crash. This could have a positive impact on an investor’s retirement prospects.

Warren Buffett’s focus on high-quality companies

Warren Buffett has always sought to purchase high-quality companies that can go on to deliver impressive profit growth over the long run. His main focus has been on acquiring businesses that have wide economic moats, or competitive advantages, over their peers. For example, they may include businesses with a unique product or a large amount of customer loyalty that means they can enjoy higher margins.

High-quality companies may experience a higher rate of profit growth over the long run. As such, this may mean that they command higher valuations that increase the size of a retirement portfolio. A larger portfolio may make it easier to generate a growing passive income in retirement.

A long-term focus on cheap stocks

Of course, Warren Buffett has also aimed to purchase high-quality companies when they trade at low prices. This provides a wide margin of safety that can mean strong capital appreciation prospects.

However, in many cases, it has taken his holdings a number of years to deliver on their potential. In fact, some of his holdings have experienced significant disappointments along the way, or have been negatively impacted by weak investor sentiment at times.

Warren Buffett has often provided such companies with sufficient time to deliver on their potential. In doing so, he has focused on the quality of the business and largely ignored how the share price is performing. And, since a company’s share price usually follows its bottom line higher, this strategy could lead to impressive returns over the long term that encourage an investor’s retirement portfolio to grow in size.

Holding cash – but not for a passive income

Warren Buffett has always held relatively large amounts of cash. Clearly, the returns on cash are unlikely to encourage a larger retirement portfolio that can offer a more attractive passive income.

However, holding cash provides the opportunity to quickly react to buying opportunities across the stock market. For example, purchasing shares at low prices following a bear market can provide greater scope for capital growth over the long run. And, as the 2020 stock market crash showed, opportunities to do so can be short-lived. Therefore, having some cash on hand at all times may ultimately lead to a higher retirement portfolio valuation that can produce a more attractive passive income in older age.  

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Returns As of 15th February 2021

Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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