Why Warren Buffett Built A Perpetual Income Machine

When studying what made Warren Buffett such a successful investor, it would be naïve to conclude that he was simply some guy who had extraordinary skill at stock-picking, and then climbed to the top of the investing mountain thereafter due to sustainable excellence in the stock-picking realm. But that only tells half the story. It would be like only discussing a famous self-help public speaker’s days and nights spent working on his public speaking without acknowledging the countless hours spent reading books acquiring the knowledge to provide the right message that was delivered in an attractive fashion.

The reason why Warren Buffett is more of a household name than Charlie Munger, Seth Klarman, Peter Lynch, Donald Yacktman, and John Neff is not because Warren Buffett is better at picking individual common stocks than those other gentlemen. Rather, it is because Buffett knows how to successfully combine the intelligent selection of individual investments with an intelligent infrastructure.

In Buffett’s case, he has been able to own private companies and benefit from the use of insurance float (which is an interest-free form of superleverage that amplifies the effects of compounding). Picture the bad years in our country’s recent history; 1973, the crash of ’87, 2001, 2008-2009, and probably a few others to lesser effect. In ’87, when Lynch was running the Magellan Fund, he had to deal with clients clamoring for redemptions—even though Lynch had the impulse to make sweeping investments, he had to deal with fundholders that were thinking, “My $100,000 is now just $80,000, screw that, I’m outta here” and acting on it by cashing out of the Magellan. In other words, mutual fund managers typically face liquidity shortfalls during times of market panic, making it harder for them to execute their craft.

Buffett, meanwhile, has a stable of insurance operations and other private companies that generate profits in the 1987s and 2008s of the economic cycle; he is constantly armed with more cash to make brand new investments during periods of low prices. People, including me, give a lot of attention to the Coca-Cola, Wells Fargo, and Washington Post investments that Buffett makes, but the lesson is incomplete if you only focus on that fact.

To truly change your life, you need an asset that throws off regular, monthly cash. That might mean something like a real estate property paid off in cash. If you are renting out a $225,000 property that you own in cash, you could very reasonably have $1,400 coming in per month that you get to use to make stock market investments. Do this for a couple decades, and you are going to benefit from rising rent checks that give you even more money to invest, and then the investments from years gone by start to throw off meaningful income all of their own, allowing you to spend your life constantly taking incoming cash and making fresh investments.

At that point, investing is an art form. It’s a lifestyle. You’re not playing the lame game of trying to beat the S&P 500 by a point here or a point there each year, but instead, you are laying the bricks of a financial fortress each month as you create a perpetual income machine that lets you build a collection of assets that keep on generating cash.

Of course, there are ways to do this without owning a private business. You can have a job where you receive a high hourly compensation so that *you* are the private business. You can buy a collection of energy MLPs yielding 8-12% annually that give you income monthly income to make new investments (most energy MLPs make quarterly distributions, but a diversified collection of them should give you income monthly). And heck, if you don’t know anything about real estate (even though I think you could educate yourself by reading some well-chosen real estate investment books and spending 6-12 months on sites like biggerpockets.com), you can still build a collection of REIT investment assets that generate 5-7% in annual income (in some years, patient investors can get 8% or more in annual income from their REIT investments if they insist on value investing with real estate investment trusts).

But to understand what truly separated Warren Buffett from the rest of the investors, you should look to the insurance operations. You should look to the other private businesses. That’s the part of the story that doesn’t get a lot of attention, but has made a world of a difference. You should stop and yourself: What am I doing right now to put myself in a position five years from now to own a cash-generating asset? Once you get $1,000 coming in each month from a passive source that you are free to invest, everything changes. You’re no longer some random dude putting $200 into ExxonMobil on computershare anymore. You’ve taken the next step to becoming a capital allocator, and you’re on the path to rapidly building wealth because you have the right infrastructure in place. If you are looking to substantially change the style and easy of your investing life, you should look to a cash-generating asset. It’s Buffett’s perpetual income machines that transformed his life.

Originally posted 2014-07-25 08:00:22.

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2 thoughts on “Why Warren Buffett Built A Perpetual Income Machine

  1. Hey Tim,

    Great post.  I’m enjoying your blog.  I also am a dividend investor and a big fan of Warren Buffett.

    Along with his supreme cash-producing vehicle, I think the other thing that set Warren apart from other investors was his willingness to go against the norm.  The most obvious way he went against the norm was to invest for the long-run as if he were the 100% sole owner of the businesses he purchased.  However, I think the other way he set himself apart was by not diversifying (especially early on).  By knowing the businesses so well and only investing in his best ideas, he destroyed the S&P 500 returns.

    Today, the concept of diversification is so widely preached that it’s essentially made everyone equal.  The only distinguishing factor is cost of investments (commissions, fees, etc.).  Owning a concentrated portfolio of “best idea” dividend stocks is one way to differentiate yourself from dividend ETFs like VYM and VIG.  Thoughts?


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