There are two ways to build wealth – the slow way and the fast way. The slow way involves saving and investing part of your income over a long period of time, in other words, building wealth using your own money. The key to building wealth faster is to use other people’s money; that is, to invest borrowed funds. This is the principle of leverage, and it allows you to multiply your investment gains. It is highly unlikely that significant wealth can be created without using this principle, barring a windfall such as an inheritance or a lottery win.
Understanding how leverage works is a basic requirement of any person whose goal it is to amass a fortune. Whether your motivation is early retirement, financial freedom, or creating wealth for philanthropic purposes, leverage is what will enable you to achieve your aim.
Investment involves the purchase of an asset which produces a return by way of income, capital gain, or a combination of both. Such assets include bonds, property, businesses and shares. Property is the most common form of leveraged investment as it is less risky than investing in shares or a business while still offering the potential for a higher return than bonds.
The rule of thumb when borrowing to invest is that the net cost of the interest on borrowed funds should be less than the expected net return from the investment. One of the fundamental principles of investing is that there is a positive correlation between risk and return. While leveraged investment multiplies returns, it also multiplies losses. Leverage is a great way to build wealth if you understand and accept the risks involved and do the research required to identify opportunities with a reasonably certainty of achieving net returns greater than the net cost of borrowing.
