Leverage

Generally speaking, leverage is the use of debt to increase returns. On the most basic level, people who profit on a home typically have used leverage. If you bought a $100,000 home with $20,000 down and later sold the home for $110,000, you made only 10 percent on the house, but 50 percent on your initial investment. That's the beauty of leverage. Companies use leverage in borrowing at 8 percent to build a new factory that generates a 20 percent return on investment. Investors also use leverage when buying stocks on margin. But leverage is associated with risk. If the company that bought the factory finds demand has dried up for its products, it may not be able to service its debt. An investor who buys stock on margin may run into trouble if the stock falls, leaving the loan insufficiently collateralized. Like sharp instruments and strong spirits, leverage confers many benefits, but only when used with care.

 

 

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