What is Leverage?
Leverage is a strategy used by businesses to increase their potential return on investment. It involves borrowing money to finance the purchase of assets, such as stocks, bonds, or real estate. The borrowed funds are then used to increase the potential return on the investment. By leveraging the investment, the investor can increase the return on their capital without having to put in additional funds of their own.
Examples of Leverage
- Buying a house with a mortgage: A mortgage is a loan that is used to purchase a house. The loan is secured against the house, meaning that if the borrower fails to make the payments, the house can be taken away. This allows the buyer to purchase the house without having to put in all of the money upfront.
- Borrowing money to buy stocks: Investors can borrow money to buy stocks, which can increase their potential return on investment. When the stock price rises, the investor can sell their shares for a profit, after paying back the loan.
- Using margin trading: Margin trading is a form of leverage that allows investors to borrow money to buy stocks. The investor only has to put in a portion of the money upfront, and the rest is borrowed from the broker. The investor is then able to buy more stocks than they would normally be able to, and if the stock price rises, the investor can make a large return on their investment.
Pros and Cons of Leverage
Leverage can be a powerful tool for investors, allowing them to increase their potential return on investment. However, it also carries risk, as the investor is still liable for any money they borrow. If the investment doesn’t perform as expected, the investor could lose more money than they put in.
Conclusion
Leverage is a powerful tool for investors, allowing them to increase their potential return on their investments. However, it also carries risk and should be used with caution. Further reading: