financial leverage

Financial leverage

Financial leverage – Apply its Awesome Power to Your Success

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Financial leverage in real estate means to borrow money or take a loan to buy a property with the intent to earn a greater rate of return than the cost of borrowing.

Give me a lever long enough and a place to stand and I will move the entire earth

Archimedes – 200 BC

The biggest advantage of leverage is that it helps you to become rich very quickly. It allows you to buy more property with your capital. It also allows you to diversify your portfolio that reduces risk and increases returns. Mortgage interest tax benefits help to reduce your taxes and increase your cash flow.

The fastest way to massive wealth creation is through the right kind of leverage. What most gurus don’t tell you is that the fastest way for you to lose wealth is to apply the wrong kind of financial leverage. You have to understand how leveraging works.

Whenever you apply leverage it automatically increases your risk. To create massive wealth through financial leverage you have to understand how to control risk.

You apply financial leverage when you either control or purchase a property with little or no money down. You are unleveraged when you buy a property with cash.

Leverage = Borrow Money to Buy Property

Unleveraged = Use Cash to Buy Property

Financial leverage plays an important part in dramatically changing your return on investment. What some investors fail to take into account is that leverage changes cash flow from a property. Higher your leverage and cost of borrowing lower will be your cash flow from the property.

The first important lesson is that you apply financial leverage only to the extent that your cash flow will permit. Investors get into trouble when they apply more leverage than what the cash flow from the property will allow.

You have Positive Leverage when your returns increase with debt financing. When your returns go down with debt financing it is Negative Leverage. Neutral Leverage is when your returns neither increase or decrease with debt financing.

Your aim should always be to apply positive leverage but there are occasions when you can succeed with negative leverage. One example is when flipping properties.

It is important to know that financial leverage affects your cash flow, equity build up, tax refunds and appreciation. If you are a savvy investor you have to know how leveraging impacts various fundamentals of your investment.

You may like to read more about Appreciation Leverage, Cash flow Leverage, Mathematics behind Leverage, Risks involved with Leveraging and how you can contain these risks.

 

 

 

 

 

 

Mathematics of Financial Leverage

Mathematics of Financial Leverage

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The mathematics of financial leveraging has always been very seductive to Real Estate Investors. This is more so at the time when markets soar. With leveraging, one uses other people’s money to enhance his own profits by acquiring additional interests in real estate. This enhancement process takes the form either of added equity, which is realized at the time the real estate asset is sold, or as additional cash-flow, as in the case of rental properties. Either way, mathematics of financial leveraging makes a compelling case for borrowing against home equity to invest.

There are risks in leveraging that must be understood by an uninitiated investor. For one thing, while leverage allows greater potential return to the investor than otherwise would have been available, the potential for loss is greater because if the investment loses value not only is a portion of that money lost, but the loan still needs to be repaid in its entirety.

It is therefore important to understand the mathematics behind financial leveraging to avoid making mistakes.

How much worth of real estate you can buy with $100,000? Clearly you can buy $100,000 worth of property in a cash deal. You can also buy property worth $200,000 by borrowing 50% of the purchase price. If you are more innovative you can buy $400,000 worth of property by taking out a 25% mortgage or better still you can buy $1,000,000 worth of property by taking out a 90% mortgage. This is interesting mathematics.

Let us say you buy a house of $100,000 in a cash deal with no borrowing. Let us assume that your tenant is paying $8000 in rent.  The operating expenses that include the rates and maintenance cost come to $3000.  You are now left with left with $6000 as cash flow from the rent. If your property appreciated by 10% during the year that is to $110,000. You will have a return of $16,000 ($5000 cash flow from rent + $10,000 in capital appreciation). This will mean that you will have a return of 16% on your investment of $100,000.

Now let us say that you decide to leverage your money and take out a mortgage of 90%. The bank will loan you $900,000 on your deposit of $100,000. You now have $1,000,000 and you decide to buy ten houses with each house valued at $100,000 as in the previous example. Let us assume that your rent of $80,000 from the 10 houses covers the expenses $30,000 ($3,000 X 10 houses) and the mortgage payment of $ 45,000 (5% interest only loan on $900,000). You will be left with $5000 cash flow from the rent. If your ten houses appreciate by 10% as in the last example to $1.1 million your return from your investment will be $105,000 ($5000 cash flow from rent + $100,000 in capital appreciation. This will result in a return of 105% on your initial investment of $100,000. This part of mathematics of financial leveraging that is so seductive to property investors

The after tax returns on a leveraged property will be much higher because you will be able to claim depreciation and maintenance costs on ten properties instead of one. Also the interest paid on borrowed funds of $900,000 can be claimed back to increase the tax refunds.

The above mathematics clearly shows how you can increase your net returns dramatically by leveraging your money.

But we should also examine the downside mathematics of financial leveraging. Let us say the property values went down by 10% in a year instead of going up in the previous example. In the case of a cash deal our loss will be $4000 for the year thereby giving us a negative return on investment of 4%. On the other hand we will suffer a loss of $95,000 or 95% of the value of the deposit in case of mortgage of 90%.

The losses get amplified in case of a leveraged property. Is it advisable to risk financial leverage in buying property? The answer to that question is a simple YES. This is because values of properties have appreciated steadily at 8% to 10% annually during the past 300 years. There are dips in the property cycle but these are far and few in between. If you have the capacity to buy and hold and manage your cash flow you will win in the end.

Please also read about mathematics behind Cash Flow Leveraging, Appreciation Leveraging, Risks involved with Leveraging and how you can contain these risks.

Mathematics of Financial Leverage

Cash Flow Leveraging

Cash flow leveraging is about how borrowing can impact your cash flows from your rental properties

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The first important thing to understand in cash flow leveraging is the capitalization rate. It is important to know how much the property is paying you. In its simplest form capitalization rate is the net rental income from the property divided by the purchase price.

Let us say you buy a property for $100,000. Let us assume gross income from this property is $14,000. Total expenses that include rates, insurance, maintenance & management come to $4,000. The net income from the property will be $10,000 ($14,000 minus $4,000). The net yield or cap rate on the property will be $10,000 (net rent) divided by $100,000 (purchase price) or 10% in this case.

The next important thing to understand in cash flow leveraging is the cost of borrowing funds. It is not a simple case of interest on your loans but must also into account the amortization cost and the loan period to work out the loan constant. Let us say that the cost of borrowing is 7%.

The difference between the cost of borrowing and the return from your investment property is called the spread. In our example above we have borrowed money at 7% and are getting a net return of 10%. In this case we have a positive leverage or cash flow on the property.

If the return from property was lower than the cost of borrowing we will have a negative leverage. A neutral leverage will occur when the cost of borrowing is same as return from the property.

When you are buying a property for cash flow you have to purchase only positively leveraged property. If you do this the cash flow leverage will work in your favor.

Investors sometimes buy negatively or neutrally leveraged property in the hope that capital appreciation from the property will overcome the short term cash flow losses on the investment. In this case you will need to support the short fall in cash flow from other sources of income. This can become very worry some if the investor loses his job or suffers losses in his business that is supporting the negatively leveraged property.

A positively leveraged property can turn into a negative leveraged property in case of loss of rental income or if the interest rates move up at the time of re-fixing the mortgage. It is therefore prudent for you to allow for the vacancy rates or changes in the cost of borrowing.

No one can allow for all the contingencies that may occur in the future. But if you can work out your figures accurately for the first five years then chances of things going wrong with your investment are greatly reduced. This is because rents will normally go up to provide you with additional cash flow. In addition increase in capital value of the property will give you with an extra cushion of equity.

A negatively leveraged property will move into positive territory given time and a few rent reviews along the way.

As an investor you will keep out of trouble if you apply cash flow leverage properly and make it a habit of buying only positively leveraged properties. This is what Robert Kiyosaki and all savvy investors do. You must always concentrate on cash flow first and capital appreciation later.

You may like to read more about Appreciation Leverage, Financial Leverage, Mathematics behind Leverage, Risks involved with Leveraging and how you can contain these risks.

Appreciation Leverage

Appreciation leverage happens when you borrow money at simple interest and invest it into a compounding investment such as real estate you can create great wealth for yourself

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Appreciation on properties compounds where as interest on properties (though not exactly simple interest) are normally in fixed installments. If let us say you buy a property in a place where the historical appreciation is at 7% and you borrow money also at 7% interest only mortgage you will find that at the of thirty years your property would have gained in value by at least 3 times more than the interest you would have paid. And better still your tenant would have paid that mortgage.

As a thumb rule if your interest on your mortgage is lower than the expected appreciation rate then you will have positive appreciation leverage.

The best properties are those that have positive cash flow leverage and positive appreciation leverage. Such properties are sure shot winners.

In certain high capital growth areas you will have properties that have negative cash flow leverage but positive appreciation leverage. Depending upon your situation you might like to buy such a property if you have problems of excessive cash flow and a very high taxable income.

No savvy investor will buy a property that has both negative cash flow leverage and negative appreciation leverage. But I amazed at the number of people who are coaxed into buying such properties by savvy sales people. You should try and avoid such properties as a plague.

The ultimate leverage is when:

Cost of Borrowing   <   Capitalization Rate

Interest Rate            <    Appreciation

You may like to read about Financial Leverage, Cash Flow Leverage, Mathematics behind Leverage and Strategies to contain Leveraging Risk

Understanding Leverage Risk

Using Financial Leverage is an excellent way to accelerate your financial growth. But to be a savvy investor you have to understand the leverage risk and learn to manage those risks.

More Leverage  =  More Financial Risk

Less Leverage     =  Less Financial Risk

You must not let the leverage risk scare you away from real estate investing because risk can be measured and controlled.

Where there is more volatility there is more risk. Volatility refers to more frequent deviations from the standard. To understand risk you have to understand volatility.

Real estate has the least volatility when compared to other investment venues. A study carried out has shown that during the past 10 years real estate was ten times less volatile when compared to stocks which tend to fluctuate wildly on a daily basis. Yet there is hue and cry and everyone freaks out when real estate prices go down by five to ten percent.

Even a highly leveraged real state is more stable than stocks. This will imply that real estate has less leverage risk than most other investments.

Even though real estate is very stable leveraging does increase relative risk.

More Leverage = More Returns = More Volatility = More Fluctuations in Cash Flow = More Fluctuations in Returns = More Risk

Let us say you buy a house at a price of $100,000 with cash down. If the price moves up by 10% in one year then you will make a profit of 10% on your investment. In this example we are not taking cash flow into account. If the price moves down by 10% then you make a loss of 10% on your investment.

In the second example let us say you had taken a mortgage of 80%. This would imply that you have made a down payment of $20,000 on the property. Now if the price moves up by 10% i.e to $110,000 then you will make a profit of $10,000 on your investment of $20,000. This will equate to a return of 50%.  Similarly if the price of the property went down by 10% you will make a loss of 50% on your investment.

This example clearly shows the amplification of leverage risk by a factor of five times if the property has a leveraging ratio of 5.

What happens to the leverage risk if your property is purchased with No Money Down deal with 100% mortgage? Your profits will be infinity if the property prices moved up. Similarly your loss will be infinity if the property prices went down. But what is your risk if you have no money in the deal?

A study conducted in 1978 found that leveraged real estate is the only investment that is fully protected against inflation. This is because when there is inflation rents go up and there is capital appreciation. However mortgages remain fixed if they are for long term.

Many investors only look at the upside of financial leverage. Savvy investors try and cover the down side of leverage by taking steps to control it if things go wrong.

Leverage Risk Containment Strategies

You can contain the leverage risk by following the under-mentioned guidelines:

Reduce Financial Leverage Just Before the Market Peaks

Most novice investors start to use maximum leverage when the market is about to peak. This is the time for you to reduce your leverage risk by selling a few properties to pay off your mortgage and increase your equity on the other properties.

Increase Financial Leverage Just After the Market Bottoms Out

This is the time when most people have deserted the real estate market. But it is exactly during this period that leveraging offers the best capital returns in the medium to long haul. Interest rates are low, so the cost of borrowing is minimized. Financial institutions are looking for customers and it is easier to cut a better deal or get incentives from them. Sellers too are more motivated and more flexible on prices and terms of contract.

You should use the equity in your properties to buy more property. You should increase your financial leverage to the maximum because during this period you will have positive cash flow properties reducing your borrowing risk.

Buy Quality Properties

Always buy quality properties. A house or multi-family dwelling that is well maintained and well kept will hold up value better in the long run, and will save you money in maintenance as well. When the markets are down it will be easier for you to find quality tenants willing and relocate into a nice-looking property. Quality properties reduce your leverage risk.

Take the profits and pay down the debt

Greed is always dangerous in any market. This is where most people fall. Do not keep reinvesting your profits to buy more property. That is like betting all winnings on every new roll of the roulette wheel. If you follow this strategy you will lose your winnings because sooner than later markets will move downward. If you do not stand on solid foundation you will lose your profits. The best and safest strategy is not to keep borrowing against your equity. Use cash-flow to pay down the loan or to wait for prices to increase and then sell for a profit to reduce your debt.

Shop for the lowest possible interest rate

Even though the interest is tax deductible you still have to pay some of it out of their own pocket. It is always advisable to shop for the best deal available, using the services of a good mortgage broker. If your loans are substantial the savings could amount to several thousand dollars every year.

Make improvements to your property to increase cash flow

Make improvements and add value to your property to increase the rents so that you have positive cash flow leverage on the property.

Deposit Recycling to reduce Leverage Risk

If you buy a property with no money down you have no personal risk as long as the purchase is structured in such a way that you have no personal liability.

It is not always possible to buy a property with no money down. At times you will be required to put some of your money into the deposit. Your aim should be to take out your personal money from the investment as soon as possible. You can then use this money to buy some more property. This is known as deposit recycling.

The best way to recycle your deposit is to firstly buy the property below market value and then make improvements to increase its value and cash flow. You should then refinance the property and take out your deposit as soon as possible. Your leverage risk becomes zero once you have none of your personal money in the property.

Once you recycle your deposit to reduce your stake in the property (eliminate leverage risk) you should allow the equity to build in the property through appreciation and repayment of loan through the cash flow generated from the property. Do not get greedy and keep taking out loans against the equity in the property.

Reduce Leverage Risk as you grow older

You can apply more leverage when you are young because time is on your side. In case things go wrong you can re-start once again. As you near your retirement age you should reduce leverage risk. Once you are retired leverage only to the extent to reduce your taxes.

Leverage Risk as function of your personality

Each one of us has a different risk profile. Some of us are comfortable at taking more risk than the others. You should study your risk profile carefully and take leverage risk to the extent you are comfortable with. You will have peace of mind.

You may also like to read about Cash Flow Leverage, Appreciation Leverage, Financial Leverage and Mathematics behind Leveraging.

 

 

 

 

power of leverage

How to Maximize the Power of Leverage to Grow Rich

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To create wealth you have maximize the power of leverage. There are three accelerators that can help you fast track your endeavor.

Acquire a Mentor

You can avoid making mistakes on the learning curve by finding a mentor who can guide you through the whole process. Your mentor has climbed the mountain—he knows the terrain and knows what works and what does not work. You can learn from the process and avoid making mistakes.

In addition, your mentor has systems. The most efficient facet of leverage is to transfer your mentor’s systems to your use. Learn from those systems and apply those systems to your business, real estate, stock market and internet.

Acquire a Team

Nature made us incomplete—we have incomplete knowledge and experience; we have to collaborate and build dream-teams to fill gaps in our knowledge and competence to succeed. Our teams can fill up our blind spots.

If you want accelerated leverage then find a competent team to help you. Your team will help you go faster. A 4X100 meter relay team runs much faster than an individual runner.

Your team can consist of people with expert knowledge in their respective fields. They don’t have to be your employees but should be available for advice. For instance, if you are a real estate investor your team will consist of your accountant, solicitor, and real estate agents who bring you deals, mortgage broker and your builder/ handyman. If these people are property investors, they will be able to give you better quality advice.

leverage

Before you start building your network, find your core group that will help you build your network. When like minded, joyful and success-oriented people work together, enormous energy is released. Try and avoid people with negative energy around them—they will drag you down.

Your core group or dream-team will provide the synergy to create an invisible force that will attract people to your network. 1 + 1 is, not 2, but 11. The sum of the parts is far greater than the whole. This is what your core group can help you achieve.

Jesus selected a core group of 12 men, and the world was never the same again. Their network and influence has lasted over centuries and continues to expand even today.

Bill Gates and Paul Allen collaborated to found Microsoft and became the richest men of all times. Larry Page and Sergey Brin founded Google that is used by millions of users and is presently expanding incessantly.

Facebook, which is the biggest networking platform of all times, was created by a team of four Harvard University students: Mark Zuckerberg, Dustin Moskovitz, Eduardo Saverin and Chris Huges. The examples that history provide are endless.

A core group constituted of an aligning team (that is not pulling in different directions) will always out-perform an individual. So, don’t try to do it alone. Build a core group first and then your network.

Loverage

Mike Littman coined the term ‘Loverage’. If you love what you are doing and are spiritually and emotionally connected with it, then success will come much easily. When your thoughts, mind, body, emotions and spiritual self are congruent you achieve unassailable heights.

Ask any sportsperson about their greatest sporting moments, and you’ll find them acknowledge that at the height of their achievement, their mind, body and spirit dissolve into a singular force. Do what you love doing and you will apply the ‘Loverage’ even without knowing.

Accelerated Wealth Creation Through Leverage

There is no such thing as a hundred percent leverage. It is a myth perpetuated by certain vested individuals who want to market their books and products. There will always be some financial, time, and effort commitment in the beginning. In due course, as the business or investment progresses, finance and time involvement can be reduced, and leverage increased.

The above arguments should not dissuade you from using leverage with prudence and intelligence. Leverage, without doubt, is the most important and powerful tool in the armory of wealth creators. However, it is of paramount importance to understand its correct usage before applying it in a fit of excitement. Initially, start applying small forms of leverage and as your confidence grows, you can increase the amount of leverage to one that you are comfortable with.

Even if you start applying a little bit of leverage in your life, you will be amazed at the results. Leverage is power, strength and intelligence.

Mark Victor Hansen and Robert Allen, in their book ‘One Minute Millionaire,’ provided a formula:

Leverage = Speed = Goals

This, in my view, sums up how you can use leverage to reach your financial goals within the shortest period of time. You can increase your returns from 5-10% offered by banks and financial institutions to over 60-70%, or even higher through leveraging.

Remember, without applying some kind of leverage, there is no possibility of creating accelerated wealth.

financial success

Why Leveraging Systems is Important to Your Financial Success?

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Achieve Financial Success through Leveraging Systems

The ultimate aim of any income stream and achieving financial success is to make it work on autopilot or with minimal supervision from you. This can only be achieved by putting proper systems in place so that it can function without your intervention. This is the ultimate leverage that will free up your time and effort to devote to other important things in life such as family, travel, leisure, creativity or other ventures that will create new sources of wealth for you.

When I was in the Navy, we had a saying that it was a system designed by a genius to be run by fools. All the procedures were laid out for us to the last detail. We knew what action to take in an emergency, what logs and forms to fill up, how to demand stores, etc. When an order was given to ‘dive’ or ‘surface,’ every crew member who was on-board the submarine knew exactly what action to take. Nothing was left to chance.

Buy a System

A well-run income stream or business should be run in a similar manner. The problem is that most of us know how to work within a system designed by others, but are clueless when it comes to designing a system for our own work or business.

The answer to this problem is to buy into a system that is very closely related to your work and adapt them to your requirement. An alternate solution is to work with an expert who has the skills to design and set up systems.

To leverage our time and effort, we have to be on a constant lookout for setting up systems to free our effort and time. These can be very straightforward things like: setting up automatic online payments for our bills or more sophisticated automated systems to put our business in auto pilot. There may be some cost and effort involved to initially set up the systems, but once they are in place, they free up your energy to do more creative work. The aim of any good system is to take care of the routine work thereby leveraging time and effort for creative work.

To become rich you need to have proper systems in place–QED. Without SYTEMS, you are doomed to failure. Research has shown that 94% of the failures are not due to the assumption that people don’t do a good job, but because either they are using the wrong business systems or have no systems in place to start with.

For the ease of understanding, the right acronym for systems is:

Save Your Self Time Energy Money

If you want to make money, then search and find a money-making vehicle that has successful systems. You will save time, energy and money if you have systems in place before you embark on money-making ventures.

If you don’t have the skills to set up systems, then buy into business/ investment ventures that have systems in place. Every enlightened wealth creator knows this simple truth. They buy into time-tested predictable systems that will do the job for them. That is why when initially starting your own business, it may be wiser to buy into a franchisee that has strong systems rather than building your own from scratch.  Chances of failure will thus be reduced. As you gain experience, you can develop your own system.

Once you have systems in place, the system will churn out money for you. All the work is done upfront to set up the system. You will only need to fine-tune it, once in operation, to make it work optimally.

leveraging knowledge

Why Leveraging Knowledge Is Greater than Financial Leverage to Growing Rich?

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Perhaps leveraging knowledge is the greatest lever that a person can apply. Your wealth creating ability depends on what lies between the two ears. One has to develop financial muscles in the brain. Intellectual leverage is the most powerful leverage. I have seen entrepreneurs amass massive wealth with nothing more than an idea.

“Thinking is hard work. When you are forced to think, you expand your mental capacity. When you expand your mental capacity, your wealth increases.” – Robert Kyosaki

The fastest method to achieve intellectual leverage is to use ‘Other People’s Experience’ or OPE. It takes too long to learn on your own—become an apprentice and find a mentor. Learn from the experiences of those who have traveled the path.

Secondly, knowledge has become so complex that no lone individual can acquire all the knowledge one needs to grow rich. Wealth is created through knowledge or ideas of other people. One has to learn the art of using ‘Other People’s Ideas’ or knowledge. This may require collaboration, or buying the right expertise to cover any grey areas that exist in our knowledge construction.

We live in an information age where ideas can be converted into wealth with relative ease. It is very similar to Eisenstein’s theory wherein mass can be converted into energy. If you look at all the new billionaires like Bill Gates, Steve Jobs, Mark Zukerberg,  Jack Ma, Larry Page, Sergy Brin, Jeff Bezoz, just to name a few, they used ideas and knowledge of others to grow rich. Most of them used financial leverage but they grew super-rich mainly due to the leverage of knowledge.

What is needed by a wealth creator is the judgment—as to what knowledge is needed for a particular project and from where it can be imbibed at the cheapest price. Our world is full of specialists who do not know how to apply their knowledge to create wealth. It is wealth creators who leverage the knowledge of the specialist to amass great wealth.

You have to develop a keen eye for talent and look out for skillful people, because these are the kind of people who will make you rich. You have to leverage, and harness the intellectual strength and talent of these people. Intellectuals consist of professionals such as accountants, legal advisors, tax consultants, etc. They fill the gaps in your knowledge. Their intellectual strength helps you grow rich.

Microsoft Corporations grew mainly due to its ability to harness the intellectual strength of young computer whiz-kids on its pay roll. Do you know that Bill Gates never created a software on his own. He either bought or hired someone to create the software that made him rich.  If Microsoft can do it, why can’t you?

financial leverage

How Applying Financial Leverage can Make You Rich

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Irrespective of whether you are a businessman or an investor, you need fund to grow. Everyone starts with personal funds, but these run out sooner than later. To create wealth one has to borrow from relatives, friends, banks, financial institutions or public ones. In other words, we have to work with ‘Other People’s Money’ or OPM.

The borrowed funds have to be productively employed to earn a higher return than the interest payable. Banks do this all the time. They borrow money from us at a lower interest rate and then give out loans to businesses and property mortgages at a much higher interest rate. They pocket the difference and create millions of dollars in profit.

To create wealth, you have to think like a bank. You have to use Other People’s Money to grow. Banks borrow money from you and pay you interest on the borrowed funds. They then loan the money at a higher interest rate to business people, fund real estate and consumer goods loans. Banks make money on the difference of the interest rate they borrow and what they charge to their customers. You can grow rich by applying the same principle.

Financial Leveraging in Real Estate

real estate investment

To explain financial leverage, let us see how it works in real estate. Let us say you buy an investment property for $100,000 at 10% down payment. This means that you make a down payment of $10,000 and borrow $90,000 from the bank. Let us assume that the rent from the property covers the interest and expenses on the property. If the value of that property increases by 7% over the year then the property would be worth $107,000. This would mean that your investment of $10,000 has earned a whopping return of $7000 or 70% yield.

This happens because you get to leverage not only on your investment of $10,000 but also on the borrowed amount of $90,000. There are sophisticated property investors who buy property with ‘no money down’ or very little of their own money i.e. they work on 100% borrowed funds. In this case, the return on investment will be infinity.

Good Debt and Bad Debt

Borrowing money and creating debt is good if the funds are utilized intelligently to create wealth through business and investment. The profits need to exceed the cost of borrowing. A debt created for consumption purposes: for buying luxury items such as cars, television, etc. is bad debt. Such debts take money out of our pockets and have to be treated with great caution.

Borrowing money is great if you buy investments that make you rich. It is bad if the borrowed funds are used for purchasing consumption goods like cars, boats, TVs, holidays etc that depreciate in value the day you purchase them.

Good debts make us rich. Poor debts make us go broke. The power of leverage in finance, when applied correctly, can make us grow rich exponentially.

financial leverage

How to Grow Rich Through Responsible Leveraging

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The power of leverage is perhaps one of the most neglected and misunderstood areas of an average person’s knowledge. One fact will become very clear if you are to study the lives of the most successful people around you; these people, without fail, apply the principle of leverage and use it to maximum effect in their life.

financial leverage

Archimedes used to say, “Give me a place to stand and with a lever I will move the whole world.” This illustrates the awesome power of leverage. Big doors swing on little hinges.

Leverage simply means ‘the ability to do more with less’. Leverage is the power to achieve a lot with little or no effort. Simply put, leverage is the key to building wealth.

To create wealth in large amounts, in little time, one has to understand and master the principle of leverage. Correct application of leverage breaks through the barrier of 10% growth/ yield. With leverage, we can grow at 50% or 60%, and even 100% or more.

Leverage, when combined with the principle of compounding, can create accelerated wealth. No great wealth has ever been created without using either leverage or compounding. Those two, when combined, together can explode your wealth. Let us examine how leverage works in the financial world.

Compounding + Leveraging = Accelerated Wealth

Robert Kiyosaki, in his book, Rich Dad Poor Dad remarks, ‘if you want to become rich, you need to work less, and earn more. In order to do that, you employ some form of leverage.’ (Kyosaki, 1997).

He further explains by saying, ‘People who only work hard have limited leverage. If you’re working hard physically and not getting ahead financially, then you’re probably someone else’s leverage.’

‘People with leverage have dominance over people with less leverage.’ In other words, just as humans gained an advantage over animals by creating leveraged tools, similarly, humans who use these tools of leverage have more power over humans that do not. Saying it more coherently, ‘leverage is power’.”

Types of Leverage

There are not one but several types of leverage that can be used to grow rich.

Financial Leverage

This is when you use other peoples money to grow rich. No one has grown rich with their own money. Sooner than later we all run out of money. You apply financial leverage when you borrow sensibly to buy assets that make you rich. The cost of borrowing has to be lower than the return from the investment or the leverage will not work.

Leverage of Knowledge

This is perhaps the biggest of all levers. No one is an expert in every field. Every endeavor in today’s world needs multi-disciple specialized to be successful. When you use your own and other peoples knowledge to projects to create wealth and be successful then it is termed as leverage of knowledge.

Leverage Other People’s Time and Effort 

No one has grown rich through their own effort. There are only 24 hours in a day and only so much work can be achieved during that period. By employing other people to do work you can earn from their effort. To apply leverage of other peoples time and effort you will need great management and human skills.

Leveraging Technology

Technology can make complex tasks simple and save hundreds to thousands of man-hours. It is also a lot cheaper for many jobs that humans perform. Cost-effective use of technology can create huge wealth in a very short span of time.

Leveraging Networks

It is not what you know but whom you know that counts towards your success in life.  You can make things happen if you know the right people. Your success is directly proportional to the people in your network with whom you have the relationship.