Whether it’s for business or personal use, knowing how to leverage debt can help anyone achieve their financial goals. When you borrow money, you can use that financial leverage for capital gains or profits.
If you are looking to find out more about financial leverage and how much money you may gain with borrowed capital, you will find this article helpful!
What Is Financial Leverage?
Financial leverage is the use of debt, or loaned money, to bring about further financial or personal gains. Successfully leveraging debt can:
- Improve overall financial health
- Increase your company’s equity
- Improve quality of life
- Help you reach personal finance goals
- Bring in new equity
How much debt you take out will help determine its usefulness as financial leverage. For example, a quick $600 loan may help you get through a financial crisis, but it won’t necessarily give you much purchasing power when it comes to future investments. When used responsibly, larger loans or investments have a much greater potential for business or personal finance benefits.
Ways To Borrow Money to Leverage Debt
We can solve business or personal cash flow issues in a few different ways. Some of them are:
- Asking for donations to raise funds
- Taking out loans from credit unions, banks, or online lenders
- Utilizing money for investment purposes
Unless you are working for a charity or another non-profit organization, it may not be best practice to ask for donations. Instead, you may want to leverage debt from your business or personal finances via loans or investing.
Types of Leveraged Investing
While some consider the stock market to be a huge financial risk, you could see significant earnings with the right investment strategy. Here are a few types of financial leverage that may help you diversify your investment portfolio.
A margin account holds funds for stocks purchased at a higher value than what the investor has. Investors expecting a stocks’ value to increase may buy it via margin investing with the expectation that the stock’s increased value will pay for the difference.
For example, a stock may be worth $100, but with margin investing, potential investors may be able to get a purchase price of $50. If the stock’s value goes up to $150, the investment would inadvertently pay for itself.
If you are new to equity markets, you may want to consult financial professionals before establishing a margin account. Depending on your financial situation, a lack of investment strategy when it comes to margin accounts could result in a massive amount of loss.
Leveraged Exchanged Traded Funds, also known as leveraged ETFs, have the potential for big profits and significant losses. A leveraged ETF requires almost constant trading, which means the entire investment could lose substantial value with just one wrong trading move.
A hedge fund is an account meant to offset the financial blow of an alternative investment account. Hedge funds require larger investments and are considered extremely risky. Due to their economic uncertainty, inexperienced investors should not contribute to a hedge fund without extensive financial information.
Real Estate Investing
Real estate investing and becoming a real estate investor can bring in some major cash when done right. Before you put your money in an investment property, make sure you’ve done your research. If the property is in a poor location or provides a service, not in demand for the area, you may not see excellent results with real estate investing there.
Borrowed Money: Good Debt vs. Bad Debt
Many people assume borrowing money and being in debt is negative when this is just not the case. The first step in making the most of borrowed money is understanding the difference between good and bad debt.
What Is Good Debt?
Good debt is borrowed money that helps you accomplish a significant or long-term financial goal. These goals may be large equity returns for business debt or quality of life improvements for personal debt.
Student loans are one possible example of good personal debt. Going to school and getting a degree is a form of personal investing. Here, the goal is to use that degree to prove your worth in a particular field. Ideally, your degree will help you get a high-paying career that will cover student loan debt in the future.
While in another asset class, mortgage debt is another example of good personal debt. Purchasing a home is a substantial financial endeavor. Still, it has the possibility to increase your quality of life as well as the potential to turn a profit. Take care of your home and perhaps even make a few improvements and you will see your home equity increase. Suppose you decide to sell your home. In that case, you may be able to get additional money than what you originally paid for your home!
What Is Bad Debt?
Bad debt is borrowed capital where the investment either does not contribute to long-term wealth or is well outside the borrower’s affordability range. Unfortunately, a vast majority of people currently have some form of bad debt.
Payday loans are a typical example of bad debt. Since interest rates are so high, payday loans are often a hindrance for those trying to reach Personal finance goals like becoming debt-free. Sometimes, the interest paid on a payday loan is more than the original loan amount. You are much better off avoiding the unnecessary interest expense and going with a better option like instant approval online installment loans.
Pros and Cons of Leveraging Debt for Your Business Without Using Your Own Money
Whether you are looking to purchase inventory, pay staff, invest in property, or take care of other business needs, there is no denying that running a company takes money. In order to get that initial cash flow, businesses have two main options; they may look for investors or take out loans.
Investors may not be the best method if you want long-term capital gains. Since investors are equity holders that play a major role in a company’s capital structure, they often have a say when it comes to company decisions and purchases. While investors do offer the great perk of having more money right away, a long-term financial commitment comes with the relationship. Before you take on investors, make sure you are willing to share profits and business decisions with them for the foreseeable future.
But, when your company takes out a loan to cover corporate finance needs, you don’t have to worry about investors pulling your company in a direction you may not want to go. Instead, you can borrow money, eventually pay off your loan and become debt-free while maintaining ownership over your business the whole time.
Furthermore, business owners may sometimes write off certain debt payments as tax-deductible. The return on this spending may give you the buying power to make other investments or purchases that may benefit your business!
When it comes to making the most of your company’s financial leverage, benefits of taking out loans far outweigh default risk.
Looking for other tips on how to utilize debt? Check out the CreditNinja blog for more free resources on how to make your money work for you and other financial topics!