How does Leverage Work with Your Money
How long would it take you to save up the money to buy a house or a car if you had to purchase in all cash?
For most people, it would take a lifetime. This is why we need to use leverage. In very simple terms….leverage is spending a little to buy a lot, or investing a little to return a lot (also known as using Other People’s Money – OPM).
When you understand and master the art of leverage and you put other people’s money to work for YOU at the lowest cost, you will rapidly build your net worth.
There are countless financial instruments in business and personal finance that you can use to help you acquire something of a greater value, whether it be in the form of cash or an asset.
Let us talk in terms of property for a moment as most people relate more easily to real estate.
When you buy a house or property, you would commonly use a mortgage which is merely a written promise you make to repay in exchange for a cash loan to finance your purchase. You’d be required to pay the lender a minimal deposit, leaving them with the mortgage and you would receive the cash tobuy more in value for less out of your pocket.
As the new property owner, you would then possess and control the property, leaving the rest of your hard earned dollars available to use for other opportunities.
While your property value grows, so too does your equity and net worth.
Unfortunately, the average person loses sight of the benefits of leverage, and rather than use it to create financial freedom for themselves, they very quickly forget about their mortgage, the scheduled repayments become a habit and the vehicle for building their net worth actually robs them of lifestyle and restricts their cash flow.
What I mean by that is that many owners feel they would be financially better off to pay down their mortgage, often paying more than required, with the intent of owning their own home outright and debt free but they shoot themselves in the foot in the process.
A very close friend of mine has spent each of the last 10 years building a house to sell on completion of construction for a profit, in order to reach the destination he has recently arrived at – personally debt free.
Like many of us, Greg was raised to believe debt is bad and now that he has paid off his home, he feels a sense of relief. This is quite an achievement and I really do congratulate him, however, how does that property support Greg’s financial future and generate a stream of income for him if he intends not to sell and continues to reside in it as the family home?
Sure, he has a well paying job that now allows him to add to his bank account balance, but how many more years would you want to sustain that kind of hard work for?
- Every extra dollar you pay toward principal in order to reduce your interest liability to own that home sooner, essentially RAISES your tax liability because you are decreasing your tax deductions.
- You are creating a situation where you will continue to work hard for your money and perhaps have enough left at retirement to fund a mediocre lifestyle at best.
In a similar situation to Greg, if you were to tap into that unused home equity (100% in Greg’s case) or simply pay just the required to your lender, then each dollar you would free up would potentially grow much faster in an asset accumulation investment, be it another property(s) or a protected share portfolio.
And when you understand how to effectively and safely use leverage and OPM, your net worth would not only grow substantially through amassed assets, you’d also be creating an additional income generated monthly by the asset so you could enjoy a better standard of living.
Like most people who begin to invest with good intentions, you may decide to leverage into property alone to create cash flow from rental returns, however you may want to also consider the flexibility of the stock market and shares.
You see, in much the same way you would invest in property for rental returns, you can easily rent out your share portfolio for consistent monthly cash flow using stock options.
Option trading strategies such as the Protected Buy Write follow the same principles and allow you to benefit from cash flow as well as capital growth and one of the major attractions is that you don’t require nearly as much of your own money upfront as you would a deposit on a property.
Self-made millionaires and banks amass a fortune because they not only effectively use strategies such as these, but they understand cash flow and the effects of compound interest when employing OPM.