Leverage Investing
Alan J. Mendlowitz, RICP, CRES
"The trick is not to lose money, the trick is to make money." - George Soros
"One of the most important things to remember when investing is that you need to use leverage to your advantage. It's not how much money you have, it's how much money you can make with the money you have." - Warren Buffet
There are a lot of different ways to achieve financial success in life. However, one of the most overlooked methods for amassing wealth is through the use of leverage. By using leverage, you can essentially multiply your investment capital and exponentially expedite growing your net worth!
While the examples of leverage in this blog are not things I can help you with in my capacity as your financial advisor, it is conceptually the final building block in this blog series. Once complete you can have a meaningful conversation with me about Multitasking your money.
What is Leverage?
Leverage is a financial term that refers to the use of borrowed money to increase the potential return on an investment. In other words, leverage allows you to control a larger amount of assets with a relatively small amount of capital. This can be extremely beneficial when it comes to making money in the stock market or real estate industry, as it gives you the ability to purchase more shares or properties than you would be able to afford if you were using only your own money.
While leverage can be a powerful tool for increasing your chances of achieving financial success, it's important to remember that it also comes with a certain amount of risk. If the investment you make with borrowed money goes bad, you could end up losing a lot of money.
Examples of Leverage
It is beyond the scope of this blog to detail many forms of leverage which use stocks and the like. You can learn more about things like Margin accounts, Futures contracts, Leveraged ETFs, short selling and forex trading from site links provided at the end of this blog.
One example of leverage which is common and basic is in the realm of real estate. (I do not deal in buying/selling real estate or in the mortgage/banking business.) Let's say your home was worth $400,000 and your mortgage was only $100,000. That means you have $300,000 of home equity. Let's imagine a two-family home a few blocks away was for sale for $500,000. You would love to buy that house as an investment property, but you lack cash to buy that home or even put down the $100,000 down payment necessary to purchase the home. Your friend the mortgage broker informs you that you can borrow an additional $100,000 from your home equity and use it to purchase the investment property. That is called leverage because you did not sell your home you simply borrowed money using the home as collateral.
If all goes okay you have two tenants and this new investment property of yours is cash flow neutral. This means the investment brings in enough money to pay the $400,000 mortgage on the investment property, taxes and maintenance, and the $100,000 mortgage on your home. In this scenario while you're not earning more money which you can spend today, you are growing your long term net worth in two ways. One, by having the tenants build up your equity by paying off the mortgages. Second, the fact that real estate can increase in value each year. This equity is something you can potentially cash in later. If at any point the investment is cash flow positive you even have more money to spend in the short run as well.
However, there is always the chance of not having two tenants all the time, having a lot of maintenance costs and real estate decreasing in value. Those occurrences would make the investment cash flow negative. Which if you don’t have other cash to pay the mortgage could make you default and lose not only the investment property but your home as well.
Conclusion
There are many examples of people who have achieved great financial success through the use of leverage. For example, Warren Buffet is well-known for his investing prowess, and a large part of his success can be attributed to his use of leverage. He was able to purchase businesses at a fraction of their actual value, and then used the debt financing available to him to increase his exposure to those businesses. As a result, he was able to make huge profits when the businesses became more valuable.
Many people have been able to achieve great success in real estate by using leverage. They would purchase properties with very little money down, and then use the debt financing available to increase exposure. In some cases, they would sell properties at a profit before even completing the purchase, and then use that money to buy more properties.
It may go against conventional wisdom because debt is seen as a downward pull on an individual's finances, but if used correctly and managed appropriately, debt can allow individuals to make purchases they wouldn't otherwise be able to, enhancing their returns significantly.
As we bring this blog series to a close, we again mention the Internal Revenue Code Section 7702 and 7702a. These insurance solutions allow you to leverage the asset’s value while avoiding much of the risks associated with the aforementioned examples. Ways to use that leverage to create arbitrage-like situations thereby earning money on your money which was already earning money. I call that multitasking money! What are you waiting for? Schedule your meeting with me - Now!
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