Leverage Your Way to Wealth
Should you leverage?
This is something that comes up each time when I discuss investment with students.
So I am going to put a disclaimer first. This is NOT investment advice. This is just Pete talking to himself out loud.
Leverage is often seen as something bad. Common folk advise is “Don’t leverage! Don’t be in debt!”
However, if you ask all the wealthy guys, the majority would share that they achieve their wealth with some form of leverage (if you are good friends, they will share the truth).
For example, businesses often take on business loan to expand, individuals take on bank loan to buy a real estate, students take on student loan to attend university.
So the key question is how to use leverage PROPERLY!
- COST of leverage – Choose a leverage instrument that is very low cost, aka low interest rates. In this case, your investment returns can overcome it easily.
- Your ability to FINANCE the leverage – Regardless of the size of leverage, so long you are able to finance it well, it should be relatively safe. E.g. if your monthly household income is $20k, your mortgage monthly payment is $6k, and your jobs are stable, IMO, that is a very safe leverage. Even if the interest raise by 2-3%, you will still be able to finance it without going negative. Therefore, if I am >10 years from retirement or have >10 years of working income, I will feel very comfortable taking on leverage because financing it is not an issue
- Your ability to CONTROL the leverage – One of the safest leverage that I personally use is mortgage loans. Mortgage loans are basically controlled by the borrower. So long, I continue to make my monthly payment (refer to point 2), the bank will never recall the loan on me (the banks just want you to pay, they don’t actually want your house). Even if my property price plummet 30%, so long I can make the payment, I am safe from liquidation. However, the same cannot be said for other types of leverage, such as stock market borrowing. In the stock market, if you borrow money to buy a stock, and the stock drop 30%, you are most likely going to be margin called.
- Investment returns > Leverage cost – While this is intuitive, I think it is worth mentioning. If you are borrowing 2% interest rate, the investment vehicle that you choose should have an average return of more than 2% per year. While it may not always be 2% each year but the AVERAGE should be more than 2%. Otherwise, you are just better off not investing.
So in my opinion, if I can fulfil these criteria, taking on leverage is actually the best and fastest path wealth (again, NOT INVESTMENT ADVICE).
If I am afraid to take on leverage, I will start small. Or start with the most common type of leverage, aka real estate.
In fact, this is the reason why business owners are so wealthy. They borrow $1 to make $3. And once the model works, they will borrow as much as the business can expand.
And that is the main difference between asset owners and non-asset owners, one uses leverage (on $, time and energy) while the other just solely rely on their own strength. Nothing wrong with that, just a lot slower to wealth.
Lastly, I must recognise that this is still not for everyone.
While the numbers make sense, there will still be some pushback such as “I am not comfortable with this”, “I think this is too risky”, “What if my investment fail?”, “How to guarantee returns?”
Risk is an inherent part of investing. No risk, no return. Or very low returns. Buy the Singapore Government Bonds for 1.8% return each year.
Therefore, it is about taking controllable risk with leverage to generate good returns.
Taking a loan to start a business has risk,
Taking a loan to buy an investment property has risk,
Crossing the road has risk.
While I cannot guarantee that all my investment will be profitable, I know that with the right criteria, the odds are on my side.
For example, I bought $1.5m investment property at 1.3% interest rate. (Cost of leverage CHECKED)
- The monthly payment is $3,775, and I can rent it out for at least $3000 so my monthly outlay is $500 (Ability to finance CHECKED)
- Based on historical returns, Singapore real estate average return ~3-6% per year. (Investment returns CHECKED)
- My worst case scenario, real estate prices tanked 30%, I am forced to hold the property for the next 5-10 years. (Holding power CHECKED)
So when I can take care of the downside, I will leverage because it is safe to do so. Especially when the Singapore Real Estate long term price action looks like a nice uptrend:
Final Words to Myself.
If taking on leverage is risky, try NOT taking leverage.
It is almost impossible for most people to have no need for leverage in their life. So I might as well master the art of taking leverage and make the best of it.
