Many people are afraid of the word debt. Getting out of debt is the subject of so many television shows, books, and magazines. However, if used properly, debt can be a positive measure, as well as a negative one.
You can use leverage to exponentially multiply your returns by using debt to invest positively. How does leverage work? By borrowing money to make more money from your investments. You may be able to achieve returns you thought were impossible by using leverage but at a greater risk of losing your money.
Here are five ways that debt through the use of leverage can make you richer.
1. Margin Investing
By investing in margin, you can purchase more shares than you actually have. You could open a margin account if you had ,000 in your traditional brokerage account.
In a margin account, you can put up to 50% of the stock’s purchase price. The broker would loan you $50,000 in addition to the $50,000 you have in cash. The broker would lend you $100,000 in addition to the $50,000 you have in cash. This money could be used to buy $100,000 in stock.
Profits can be reaped if the stock price appreciates, and the loan can be repaid. Margin calls may be issued by your brokerage firm if the equity in your account drops below a certain value. When you don’t have enough funds to meet a margin call, your broker may liquidate your entire stock position, leaving you with a loss.
2. Short Selling
On a financial program have you ever heard that you should short the market? Basically, short selling involves borrowing shares from an investor and selling them in the hope that the shares will decline.
Those who have correctly predicted declines in stock prices have made a fortune. Short sellers can lose much more than the initial investment when short selling because losses are unlimited.
3. Leveraged ETFs
Investors and traders can take advantage of leveraged exchange-traded funds (ETFs) by going long or short on an index. Leveraged ETFs like those offered by ProShares allow investors to multiply returns (and losses) between 200% and 300%.
Investments in these funds can be made in specific indexes, bonds, commodities, or sectors. Leveraged ETFs have an extraordinary profit potential. Leveraged ETFs can provide investors with returns like none other during market booms.
Leveraged ETFs can also work against you in the same way they can work for you. Leveraged ETFs can magnify losses by wiping out your entire investment in a few days if you’re not great at trading in and out of them.
4. Forex Trading
Forex trading allows investors to control large amounts of currencies with a small investment. A 100:1 leverage is available for currency investors. Forex trading has the benefit of allowing you to take a small amount of money and turn it into significant sums very quickly.
By betting against the pound, George Soros made $1 billion and is known as the “man who broke the Bank of England”. Alternatively, currency trading can deplete a trader’s account in a matter of minutes.
5. Hedge Funds
Leverage is a common tool used by hedge funds. Leverage has been known to generate abnormal returns for hedge funds. Hedge funds often leverage as much as 10 times their total assets. Many billionaire hedge fund managers have turned accredited investors into multimillionaires using leverage.
However, if the investment thesis of the fund manager is wrong, the fund can be forced out of business, causing all investors to lose money. LTCM, a hedge fund that needed to be bailed out, was leveraged 30 times its assets.
Contrary to conventional wisdom, debt is seen as a drag on an individual’s finances, but if used and managed appropriately, debt can help individuals make purchases they wouldn’t otherwise be able to make, thereby enhancing their returns significantly.