Investment Leverage

In the United States, the total amount borrowed in margined brokerage accounts has now surpassed $500 billion. There are no doubt billions more are borrowed from banks and other lenders. For many people, leverage makes sense. For a while. The trick is to know when to stop.

How leverage works

The idea is if you invest more you make more in a rising market. Seems simple enough.

Suppose you have $50,000 and invest it at 7%, in five years you would have $70,000. Plus $20,000. But if you invested $100,000 at 7% and paid 3% interest to get the extra $50,000, in five years you would have $131,000 less the $50,000 you owe. $81,000 A gain of $31,000. $31,000 is more than $20,000 so why not have it?

If you could earn 9% before costs, you clear $43,800.

When the market is raising there seems to be no risk.

“I think without a doubt, that what is called “financial genius” is merely a rising market.” — John Kenneth Galbraith

Many greedy people expect to make far more than 9%. Leverage makes sense to them. Greed is a powerful motivator. But we often find it is a misdirecting motivator.

The other side of leverage

Market don’t always go up. The apparent rule is markets fall faster than they rise. Why? Because fear easily overcomes greed as a motivator.

If you have $50,000 invested and lose 30% you are left with $35,000 to reinvest and grow from the bottom.

If you invest $100,000 with $50,000 borrowed at a debt ratio of 50% of value. The $100,000 becomes $70,000 of stock and a loan of $50,000, so $20,000 is yours. The broker would sell $30,000 so the ratio came into  line and you would have $40,000 working for you with $20,000 still owed to the broker or bank.

Leverage at 50-50 ratio means any losses will be doubled plus the interest you paid.

Fifty-fifty leverage may increase your return or magnify your losses. The losses matter more. They reduce the amount of capital used to recover.

Buffett’s Wisdom

“Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.”

On Long Term Capital Management’s leverage driven collapse, “.. to make money they didn’t have and didn’t need, they risked what they did have and did need. “”

“If you’re smart you don’t need leverage and if you’re dumb you shouldn’t be using it.”

Buffett leaves a pretty narrow demographic within which someone should be using leverage. Are you in that space?

The bits to take away

Markets adjust, often dramatically.

Leverage works both ways. Consider the downside.

Greed is counterproductive. Eventually, it distorts your viewing point.

Be willing to reduce leverage if you have any left.

Help me please. If you have found this useful, please subscribe and forward it to others.

I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email to

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: