I’m following Warren Buffett’s advice for sustainable passive income

Investing in the stock market can be a great source of passive income. But finding quality stocks with attractive dividend yields can be a challenge these days.

So what can I do? Should I accept lower returns from quality companies, or seek higher returns in safer investments?

High yield

According to Warren Buffett, the answer is simple:

If you should earn 3% and you only earn 1%, the answer is stop giving 3%. It is not to get one to three and do more dangerous. You should always adjust consumption to income – you should not try and adjust income to consumption.

In other words, Buffett thinks that taking greater risks by looking for higher-yielding stocks is dangerous. I agree – if a company cuts its dividend, then the stock price will go down.

A good example of this is Hargreaves Lansdowne. The stock has yielded a dividend of over 4%, but I think it looks risky.

The company pays out almost all of its net income as dividends. Personally, I don’t think it’s a problem, but the income is going down.

If the dividend is going to be cut, then the stock price will go down. This illustrates the dangers of seeking greater returns from cleaner companies.

Quality business

So what should I do? Buffett has the following advice:

People say ‘well I’ve saved all this money my whole life and now I can only get 1% on it, can I?’ The answer is that you learn to live in the 1%, unfortunately. And you don’t go and listen to some salesman come and say ‘I have some magic way to get you 5%.’

I think that what Buffett has in mind here is illustrated by Move right. The stock currently has a dividend yield of 1.37%, which is almost invisible.

Rightmove shares look like a more durable investment to me than Hargreaves Lansdown. And that’s important when it comes to passive income.

The company distributes just under 35% of its earnings as dividends and those earnings are growing. Rightmove also boosts shareholder returns through share buybacks.

Dividends

Warren Buffett’s advice on passive income is clear. It is better to accept lower returns from quality businesses than to seek greater returns from cleaner stocks.

Even with the best businesses, dividend payments are not guaranteed. There is certainly a risk that Rightmove’s management decides to suspend the dividend, as it did in 2020.

The bottom line is that companies are not forced to do this. And since then, the dividend has been restored at a higher level than before it was cut.

I follow Warren Buffett’s advice on passive income and staying in a business that lasts. Although the results offered are lower now, I think it will be better this time.