Right & Wrong Ways to Use Leverage

Leverage sounds like a golden ticket to the uninitiated. In reality, it is a tool like any other.

Very, very few have ever gone bankrupt from buying & holding. Many more have lost everything when they used leverage the wrong way.

Leverage = a loan. The idea is you have 10, so you borrow 90. Now you have 100. You buy something worth 100 that gives you 10 a year. In one year, you have doubled your money.

Sounds great as long as everything goes up.

Now we’re in a recession—yes, we really are despite no “official” announcements from anyone, because we have had two quarters of negative growth and any failure to call it a recession is purely a political calculation. They “officially” changed the definition of recession to be whatever they feel like that season. I’m not making that up.

The bear market is in season, the novices are panicking about their investments being down, and the seasoned are yawning and waiting for the cycle to resume.

Those who were overleveraged are badly bruised this year. You could’ve made strong gains the entire last two years and had it all wiped out.

Meanwhile, the boring people buying and holding, stacking sats with long time horizons (10+ years) have nothing to worry about.

Good Leverage

The best leverage is when it directly translates to dollars made.

For example, say you have a popcorn business. Your pipeline and process is all set up. You just need money for materials: corn, butter, salt.

Every $10 of materials you buy generates $50-worth of popcorn. Great! Borrow as much as you need. You don’t have to spend it all at once—and in fact you shouldn’t.

Spend as much as you need at a time. Borrow $200, and maybe spend $20 just to start. Worst-case scenario, you struggle, decide to the business isn’t worth the hassle, and eventually break even.

Best case, you sell out ASAP and spend all $200 of borrowed money to generate $1000.

Now you can return the $200 plus interest, and have over $700 left to keep going. Or take another loan and scale even bigger, if you can.

Bad Leverage

Bad leverage is buying and holding an asset on pure speculation. E.g. buying a house, waiting for it to go up in a year just to flip it.

Buying a house isn’t wrong, obviously. But buy with the right intention. If you’re going to buy it and slowly pay it off over time…that’s okay, I guess.

If you’re buying to rent it out and generate income, that’s much wiser, from a financial standpoint. You’re essentially buying an income-generating asset that you can expect to also appreciate over time.

If you’re adding in another element, like renovating a place you’re living in, or renovating and then renting out the asset (for a better price) then you’re also de-risking the asset and making sure it appreciates over time.

Rule of Thumb

For me, I will only borrow money when I know I can immediately turn it around and, in a relatively short time frame, turn it into income.

I will not borrow in order to buy and then hope🤞 it rises in value. That’s what dollar-cost averaging is for.

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