Leverage is a technique used by investors to increase the potential return on investment. In simple terms, leverage means using borrowed funds to invest in financial instruments. But how exactly does it work and what are the associated risks?

Leverage can be a double-edged sword for the investor, because it increases the potential return, but at the same time increases the risk of loss. Leverage is expressed as the ratio of debt to the investor’s equity. For example, if an investor uses $100,000 of equity and $500,000 of debt to invest, the leverage is 5 to 1.

Leverage can be useful to increase the potential return on investment. For example, if an investor uses $100,000 of equity and $500,000 of debt to invest in an opportunity that produces a 10% return, the actual return on investment would be 60%. However, if the investment produced a 10% loss, the investor would have lost 60% of their capital, which demonstrates the potential risk associated with leverage.

The use of leverage is common in the real estate market, where investors use mortgages to purchase property and generate income through renting. However, leverage is also used in trading financial instruments, such as stocks, bonds and mutual funds.

Leverage is not suitable for all investors, as it increases the risk of losses and can lead to a decrease in equity in the event of losses. Investors should always be careful to use leverage only if they fully understand the associated risks and have the financial capacity to bear any losses.

In conclusion, leverage is a technique used by investors to increase the potential return on investment, but it is also a double-edged sword that increases the risk of loss. Investors should always be careful and fully understand the risks associated with leverage before using it.