What is Leverage and How to Benefit From It

When considering making an investment, usually the first question you ask yourself is whether or not you can afford it. When using leverage you are instead asking whether you can borrow the money for the purpose of swift reinvestment and in a way which minimises overall risk, so that you can make a net profit. Using leverage to your advantage isn’t for everyone, but when done right it is a great way to maximise your investments and build wealth.

 
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WHAT IS LEVERAGE?

Leverage in finance is using borrowed money to make an investment that you will later profit from. The basic premise is that you can make a return which is larger than the borrowed amount, earning you money without actually paying a cent in the long run.

This can of course be risky depending on the investment, which is why so many people avoid using leverage, instead opting to save and use their own money so that they aren’t putting themselves at risk of failing to meet their debt obligations.

An example of leverage that is extremely common is getting a home loan, which is leveraged by your bank. This example of leverage is usually not particularly lucrative as, by the time the loan has been paid off, you will not walk away with any net profit.

If, however, you were to borrow money to buy property and then immediately sell that property at a higher cost, you would have generated a net profit and successfully leveraged money from the bank to do so, though this is considered a high risk investment.

WHY YOU SHOULD USE LEVERAGE

Contrary to common belief, anyone can use leverage to their benefit, not just wealthy people who have enough money at their disposal to minimise their risk. One accessible way for the average person looking to invest to use leverage is to use it to boost returns.

If you are considering making a profitable investment with a set amount of money, you can borrow the same amount of money to potentially double your investment. Because you are investing a larger sum, the reward should theoretically also be larger.

You will need to ensure that the extra profit from increasing the investment will be greater than any obligations arising from your leveraged source of funding (e.g. interest repayments, loan repayments, etc.) in order for this to work.

Another benefit to using leverage is to create an enforced savings plan. By putting borrowed money into a high interest savings account, that money will start accruing interest immediately. This will result in a higher pay off than if you opted to start saving from scratch.

When done well, borrowing money to finance an investment can allow you to multiply your returns while minimising risk. Contact us if you would like to learn more about how you can use leverage to increase your potential investment returns.

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