Updated: Apr 24
Learn the power of leverage in simple terms and understand how to apply it to finances!
Imagine you have a lever to move a heavy boulder on the ground...
Because the fulcrum is closer to you, and further from the boulder, it actually INCREASES the effort you need to apply in order to move the boulder. In this case, you have a short lever.
But imagine this scenario instead:
(you) ^ (Boulder)
Because the fulcrum is closer to you, giving you a mechanical advantage on the boulder, you can move much more weight! Your lever is longer, giving you "leverage".
Why debt is leverage #debtisleverage
In finance, Leverage is the use of debt, as opposed to equity or cash, to finance the purchase of investment assets. Assuming that there is an increase in the value of the investment, leveraged finance is done with the aim of increasing the potential return on investment. Leverage can be used to finance anything from buying a home to stock market speculation. Businesses are widely using leverage to finance their growth, families are using leverage in the form of mortgage loans to buy homes, and financial professionals are using leverage to increase their investment strategies.
If debt (borrowing money) didn't exist, the path to the riches of your dreams would be simpler, but much slower, and in many cases, completely out of reach! As you remember, debt is simply leverage. Without leverage, there is no mechanical advantage. So if we imagine this situation with a boulder, you would be picking up the boulder with no help to move it!
(How do I move that thing???)
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I ( )
That's a boulder, with some imagination
In terms of Finances:
(How do I afford that house???)
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I I I
That's a house, with some imagination
Take a look at this new lever showing the use of leverage to improve your finances:
(you) ^ (Wealth)
Notice the fulcrum is far away from you, helping you achieve the massive returns. Imagine the fulcrum as the quality of your investment. If you're investing money to make a 30% return, you have a mechanical advantage as seen above. If you invest money to have a 30% loss, you have a mechanical DISadvantage as seen below.
(you) ^ (Wealth)
Look at how much harder it would be to achieve your wealth with a 30% loss working against you, rather than WITH you. If you're borrowing money on something that loses value, you are at a combined 60% disadvantage as opposed to someone with borrowing money for a return of 30%.
How does this apply?
Imagine looking at a newer car to get to work. You need to make money, but work is too far away to reasonably walk to. You might have $500 saved.
Without leverage, your purchasing power limits you to buying a car worth $500 (actually less, for taxes, registration, etc). For $500, you are likely to find a car that needs a lot of work or is unreliable. It might cost you several hundred dollars for repairs, it might break down on you, or worse, it might cost you your job!
Luckily in our world of finances, we have options... options such as using debt as leverage. You decide your job could easily support a loan for a $5000 car. Using your good credit and your $500 as a down payment, the bank gives you a loan for the remaining $4500 so you can get a reliable car to get to work. This car theoretically will break down less and require less maintenance than the $500 car, costing you less time and frustration in the long run.
This is the power of leverage! You are the same person, with the same amount of money, but leveraging your credit and income into a better situation! Because of leverage, you are able to achieve so much more.
“Debt usage is the quite possibly the biggest determining factor of your financial future”
Do you want to be rich? Borrow money for assets. Do you want to be middle class? Borrow money for wants. Do you want to be poor? Borrow money for needs.
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