Harness Money

‘Leverage’ is just a fancy term for using debt in order to achieve financial goals. These financial goals are increasing your returns.

Leverage is nether good nor bad, it is just a tool. Is it a bad thing that people take out a loan to buy a home or go to college? Without the ability to take out the loan these people would not be able to afford these things.

I would argue that consumer home ownership and a college education has been a net benefit for American society.

But it is definitely bad when consumers ‘abuse’ debt. Or take out more than they can truly afford. This is where the grey area comes in. Is it immoral to purchase a much bigger home than you can truly afford? Or to go to a college that is much more expensive than a the cheaper state school. For many people everything works out fine. But then for a large number things do not work out fine and they have to work the rest of their life to pay for these bills keeping them on the treadmill.

Each person should ask themselves the question: How much debt is right for me?

The majority of people would say zero. But that might not be realistic. No debt is by far better than too much debt.

In my own life I have never taken out an installment loan. Not for a car, house, education or personal loan. This does not make me better or worse than anyone else, it is just how my life path turned out. And things have worked out for me.

Now, my sibling went to University and then medical school. She took out a loan more in loans. And she became a doctor. Today, she has a much higher salary than me. She services her loan and pays taxes and has a good amount left over for living expenses.

Things worked out for both of us. Just different paths.

Where does leverage come in?

In my post: Think of Investing Like A Game With Levels I discuss how to start your money journey and treat it like a game with levels trying not to skip from the first level to the 5th level. Methodically going through each level, because each new level provides a layer of security.

Many people get into trouble with leverage aka debt because they take out the leverage first before they have created a solid financial foundation. They purchase a house that is too large and then fight with their spouse, because they are stressed about ‘spending too much’ when the problem really lies with the fact that they did not create and emergency fund first, but instead purchase a house that put them right on the financial edge.

Start with your foundation.

And then you will earn the right to use leverage buy a house or start a new business or invest in something.

If you do decide to use leverage there are few things you need to know. I am still these things and trying to get better at them.

The first things is cash flow. How much top line cash flow are you generating each month?

Next, what do you actually take home? After all fixed and discretionary expenses how much is left over every month?

Then, how much will it cost to service my leverage each month? This is how much you will have to come up with to cover the costs of the leverage each month.

Leverage should always be a percentage of your take home income that you are comfortable with. 30%, 50%, 70%. The higher the percent the less you will have to spend each month on life items like food, gas, travel, fun etc.

Leverage can used to boost your lifestyle, but people also use it to boost their returns. Businesses do this everyday. They take on debt in order to grow their earnings aka the size of the business. They can do this because hopefully their cash flow grows every quarter so they are always making more money to service the leverage.

But individuals can also do this.

This is why I have been thinking about leverage. I use leverage in a small portion of my portfolio to boost my income returns. My leverage allows me to purchase more dividends stock shares which has increased my monthly income. But I do have to service the leverage, which is why I keep the amount of leverage outstanding to a minimum. I want to make sure that I can always cover the cost of the leverage.

Because I own more shares of stocks, if the stocks go up or down my returns will also be outsized, another reason that you need to be careful and keep leverage to a minimum. During a downturn your negatives are amplified.

People also user leverage to purchase multiple cash flowing rental properties. The idea is the same as purchasing dividend shares. The more cash flow you generate the more assets you can purchase over time.

How are your management skills?

Whether you own a home or run a business you need to become an accounting manager. Know those numbers and always be adjusting to your own economic climate.

Leverage is not something you should fear, but you should have a solid understanding of its consequences if you do abuse it.