Leverage

Leverage involves using borrowed capital to increase the potential return on an investment. It is a double-edged sword that magnifies both gains and losses. A leverage ratio of 2:1 means for every dollar of your own money, you borrow an additional dollar.

In real estate, leverage is commonly used through mortgages. A 20% down payment on a $500,000 property gives you 5:1 leverage. If the property appreciates 10% to $550,000, your $100,000 investment gains $50,000, a 50% return. However, a 10% decline means losing half your investment.

In financial markets, leverage is available through margin accounts, options, futures, and leveraged ETFs. While institutional investors use leverage extensively, it adds significant risk for individual investors. Margin calls can force you to sell at the worst possible time, and losses can exceed your initial investment.