October 12, 2010

Leverage

Leverage for the most part is bad, very bad.  Leverage is simply multiplying the effects of what you are buying and it will cost you.

The most common leverage is the use of margin which is basically borrowing money from the brokerage firm who holds your stocks or mutual funds to buy more of the same.  If stocks go up, you multiply the effects and can do very well however, the reverse is also true, and when stocks go down, you will not only have mutiplied that outcome but made it worse because you are paying to borrow money at the going rate, ouch.

Another common use of leverage is real estate and up until recently you needed 10-20% of the cost of the property and then borrowed the rest from the bank paying your mortgage and hoping the price of your house went up.  This worked out well for years until the real estate bust of 2008.  Before then, house prices slowly but surely always increased.  We now know the painful truth that home price increases are not a guarantee and leverage in real estate can cause a terrible outcome.

Leverage can sometimes be great and we all know someone who bought land or real estate or margined stocks and did very well but quite frankly, those are rare instances.  My advice is that leverage is not for everyone and if you can avoid it, do so.  Pay off your house as soon as you can and do not borrow money against your stocks or mutual funds.

1 comment:

  1. Leverage is awful. I had over 10 million in stocks and my broker advised me to buy more on margin, I did, stocks went down more, I got a margin call and sold almost everything to pay it all off, I have 200k left!

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