Steps to the Art of Leverage: turn a little into a lot – maybe

For anyone that wants to recover and stay ahead in these volatile times, you have to develop and hone constantly a leverage mindset.

Many people associate the term leverage with financial leverage or borrowing money. Here are the simple steps to leverage:

Step 1 Look at all cash transactions: I can invest $1 cash and double it (2x) and have $2 cash.  I made a $1 profit ($2 – $1 original investment = $1 profit).

Step 2 Look at the alternative of borrowing: Or, I can still invest $1 but borrow $9 and invest a total of $10.  If I double my total investment of $10, I now have $20.

Forgetting taxes and interest on the debt, I can pay back the $9 I borrowed: $20 – $9 borrowed (my leverage) = $11 net cash. $11 – $1 original cash investment = $10 profit

In my all cash example, I made $1 profit.  In my leverage or borrowed money example, I made $10. 

In sum, with leverage I enlarged my bet from $1 to $10 and made 10x the profit ($10 profit in example 2 versus $1 profit in example 1).

Now, this example shows positive leverage – you make money on the money you borrowed or leveraged. 

The reverse can happen – negative leverage - where you lose money on borrowed money.  That is what was at the heart of the financial crisis – over-borrowing personally, in business and in finance. 

In effect, investors put too little money down to buy and control real assets.  Personally, people borrowed to buy stuff – not real assets, which include their house.

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