Leverage is a powerful tool to expedite your path to wealth. Leverage, sometimes called other people’s money (OPM), can also destroy your wealth, progression, and livelihood.
I read in a book (I can’t remember which one) that you can only become as rich as the amount of money you borrow. For example, if you borrow $1 million, your wealth can reach this level.
I believe this statement, but not from a mathematical standpoint. I comprehend it to mean from a financial sophistication point of view.
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Using leverage takes a lot of knowledge, teamwork, skill, and due diligence. In essence, when you walk into a bank or investor meeting, you must know what the hell you are saying.
Today, I will talk about some concepts of leverage. However, most importantly, I will discuss how to de-leverage and prevent disaster.
Leverage in real estate. Perhaps the most popular or well-known form of leverage is in real estate. You provide a 20% down payment, and the bank gives you the rest—how nice of them.
Once you have your first property, things can get interesting rather quickly. If the housing market is hot, you can gain significant home equity in a short amount of time.
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You can tap your home equity to purchase another rental home. Rinse and repeat this; you can have 5-8 homes in 10 years.
However, maintaining houses costs money as well. The housing market can go sour really fast, especially when someone manipulates interest rates, like in 2022.
I own three homes, and I have enough home equity between them to purchase another house. However, it’s a timing issue, and I also have a family in tow. Remember, leverage is a double-edged sword—wield it carefully.
Leverage in investing. You can also use leverage in the stock, bond, and crypto markets. Once you have invested a decent amount of money, you can borrow against it—this is called margin.
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Unlike buying real estate, you are buying paper assets. The equity markets are incredibly emotional. You can trade on fundamentals, but a scary headline can send your investments in the wrong direction.
The idea of margin is to borrow against your current “safe” investments to follow a speculative lead. Let’s say you have $200,000 in Apple (APPL) stock.
You believe that SoFi’s stock (SOFI) is a fantastic deal under $4. You borrow $50,000 against your Apple stock to purchase 12,500 shares of SoFi.
SoFi stock moves to $8, and you sell half your shares to repay your margin loan as fast as possible. You still own 6,250 shares of SoFi. Obviously, this is a perfect scenario.
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Leverage in business. Most businesses fail, mainly due to leverage. Your business can stay afloat indefinitely if you can afford it.
As an entrepreneur, it’s your job to generate a profit from thin air. You create a business, build it up, and turn a profit. At least, that is the prevailing thought process.
However, when you use other people’s money, they want a return on their money—and they want it now.
You can either assume debt (bank loan) or equity (shares in your company) to build your business. You can even use a combination of both.
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The best way to use leverage in business is to accelerate your business’s growth. This means you already have a winning formula; you just need to hire more people, advertise, and buy better equipment.
Managing leverage. Leverage is a tool that most people should use. In fact, you are using leverage when you take a student loan.
However, applying your basic budgeting tools to your leveraged life is the best way to manage leverage.
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You should always have some fear of the unknown. There should be a “what if” scenario floating around your brain at all times.
What if the housing market crashes? What if interest rates turn against me? What if my hot new product does not survive past Christmas? What if Chat GPT destroys Google Search?
Turn fear into financial success. Just because you fear something doesn’t mean you must run and hide. Use your fear as a way to make better decisions.
I wouldn’t recommend trading on margin at any point. There are just too many things that can go against you when it involves emotion.
But you can leverage your safe investments, like blue chip stocks, to sell covered calls. Here you use 100 shares of AT&T (T) to sell insurance to another investor.
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You keep the shares and the insurance premium if the price doesn’t increase to the agreed-upon amount (strike price). It is a boring process, but you are using your own form of leverage.
Success in home equity. You can leverage your home equity in many ways. It’s best to have a plan to pay the increased mortgage price.
You can diversify your home equity by using a cash-out refinance to start an income-investing portfolio, start a business, or buy land.
In these scenarios, you are using your own leverage to invest and access many different asset classes. Diversification will help insulate you from the next recession or downturn.
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Sometimes the best leverage is no leverage. Understanding leverage is one thing, but using it is another. You will think leverage is a simple process if you read too many books.
However, there is a human element. You must take into account the lives of those you support. I have a family, and they come first.
As much as I love to leverage and use math, I take things slowly. I use no leverage with my book business. I am growing 100% organically.
This means it will take 5-10 years to turn any meaningful profits, but I have something important right now—a risk-free asset.
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A no-leverage business. I can create as many books as I want for free. If they sell, great. If they don’t, move on to the next.
Now imagine if every book cost me $200. And I spent $200 advertising each book. Things can get out of hand very quickly.
Could I become a leveraged millionaire quickly if a few of my books reach the mass market? Of course.
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Conclusion. But I can keep the leverage in the box. I own multiple properties, which I can use to my advantage. Once I pay off a house or interest rates decrease, I can review my options.
The world will chew you up and spit you out if you don’t take control. The more leverage you use, the less control you wield. You put your future in the hands of market forces, and that’s not a good way to live.
Taking a measured approach to leverage and exercising it with caution is good. Safety can be extremely valuable to you.
Once you achieve specific goals, use that time to de-leverage and take a breather. Once it’s clear, leverage up again for a season. You can take the fast and slow lanes to create a safe fortune. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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