Leverage is a technique that allows
you to use a small amount of your own money to make
an investment that you expect to increase in value.
In that way, leverage can increase your buying power
and give you control of potentially valuable assets.
Leverage is more common than you may think. For instance,
when you take a mortgage,
you’re using leverage
to pay for something you can’t buy with the cash
you have on hand. When the mortgage is paid off, you
get to keep any profit you make in selling the property.
You can also leverage stock investments by buying
on margin. In this case, you use some of your
own money and borrow the balance of the stock’s
cost from your broker.
If the stock increases in
price, you can sell at a profit, return the amount
you borrowed plus interest, and pocket the rest.
Because you’re putting up less of your own
money, the return on your investment can be much
larger using leverage than it would be without leverage.
For example, if you use $5,000 of your own money
and $5,000 of borrowed money to make a $10,000 investment
you sell for $15,000, your return is $5,000 on a
$5,000 investment, or a 100% return. If you’d
used all of your own money, you’d realize $5,000
on a $10,000 investment, or a 50% return.
