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The wealthiest people, billionaires included, regularly take on debt to finance their investments. It’s called debt leveraging, and it’s one of the most powerful tools for building wealth.
At its simplest, leveraging debt means borrowing money to invest, allowing you to control a larger asset or investment position with less of your own capital. When it works, it generates bigger returns than you would have been able to get with just your own capital. But if it fails, the losses can be larger as well.
But with the right debt leveraging strategy, thorough due diligence, and careful risk management, it can pay off exponentially.
How Debt Leveraging Works
There’s good debt and bad debt. When you borrow money to fund an asset or investment that has the potential to grow in value and deliver returns, that’s good debt. Examples include mortgages, loans to expand your business, and borrowing to invest in shares or a fund.
Bad debt is borrowing money to fund an asset that’s unlikely to grow in value, may yield no returns, and depreciates quickly. For example, borrowing to fund everyday expenses or depreciating assets like a car.
Leverage works with good debt. As your investment grows in value and gives you returns, you’re able to pay back the loan and still make a profit.
Of course, it’s not always as simple as that. Good debt can turn bad if your investment crashes and you make a loss. That’s why due diligence and risk management are important when leveraging debt.
Here are some real-life examples of debt leveraging.
- Getting a mortgage to buy a property, then using the rental income and property appreciation to pay back the loan.
- Getting a business loan to expand operations, buy inventory, or get new equipment with the expectation that revenue will increase beyond the cost of the loan.
- Getting a margin loan against your securities and using the money to buy more securities. This can amplify your returns but also carries a risk of a margin call if the value of your investments declines.
- Doing a leveraged buyout, where you borrow money to acquire a competitor and increase market share.
Pros and Cons of Leveraging Debt
The biggest advantage of leveraging debt is the ability to amplify returns. Borrowing money lets you control larger assets using less of your own money, which magnifies your returns when the investment goes up in value.
For this to work, your ROI must exceed the loan’s interest rate. For example, borrowing at 4% to invest in an asset that earns you returns of 8% per annum.
Leveraging debt can also amplify your losses, which is the main downside of borrowing to invest. If your investment declines in value, your losses are magnified, and you still have to repay the loan and interest.
How to Build Wealth and Minimise Risk When Leveraging Debt
Leverage debt only if you’re confident it’s the right move for you and you’re financially savvy enough to understand the mechanics of how it works (or you have a financial advisor who does) and can conduct due diligence.
You should also be patient; it may take 5 or 10 years to see a worthwhile return. Leveraging debt is the most effective and safest long-term wealth-building strategy.
Here are a few other things to keep in mind if you’re thinking about borrowing to invest.
- Risk management is important. Debt leveraging is a high-risk investment strategy. Understand all the potential risks you’ll face and mitigate them as much as possible.
- Interest rates matter. The lower the interest rate on debt, the bigger the profits. In most cases, fixed rates are preferable because they provide stability and make cash flow more predictable.
- This may be obvious, but make sure the returns on your investment are enough to service the loan even during downturns.
- Interest payments on your debt might be tax-deductible. Ask your tax or financial advisor whether you’re eligible to claim the deductions.
How PSA Capital Investments Can Help You Leverage Debt and Build Wealth
At PSA, we operate on both the borrowing and investment sides, offering a one-stop shop for investors who want to borrow money at low interest rates and invest it for higher returns (over 8% per annum). We offer low-risk investment options, making debt leveraging safer for investors.
Whether you want to borrow money to invest or you’re looking for secure investments with reliable returns, give us a call at (03) 9847 7689 to discuss your options.
Disclaimer: The information contained in this document is of a general nature only and has been prepared without taking into account your objectives, financial situation or needs.
