Leverage Discussion

Been thinking a lot about this lately. Sparked in part by my ever increasing tolerance for risk, my goal of “retirement” by 45, and through conversations with risk-averse people in general. Here’s my 2-cents.

I’ve worked with some of the wealthiest individuals and families in the country. My guess would be that 70% have gotten extraordinarily rich via leverage (be it in their business or real estate - almost NEVER through marketable securities), 20% just inherited it, and 10% through a slow grinding savings plan based on lifestyle austerity. You could mix in high income earners ($1m+/yr) but they’re few and far between. Don’t hold me to those figures, just a cursory assessment without going through my records.

Lately this discussion has come up time and time again. My take is that those who fear leverage or don’t understand it and make an average, or above-average pay are destined for a life of painfully slow wealth accumulation. Essentially, working until 65 or longer with no idea what to do with themselves outside of work. I think for a long time I was trending down this path. Head down, work my ass off and try and save as much as I could. I did own real estate in my 20’s, but just buying and selling primary residences with the goal of a bigger-house. Sheer stupidity looking back on it.

In my 30’s I began to leverage up - mostly real estate which gives you far greater leverage than a margin account. But also leveraging my stock portfolio when prices are depressed. So far, so good.

Now I’ve seen people get blown up using leverage. Of course they’re the ones who are now scared out of their mind and tell their friends to watch out. The main reason these people get blown up is emotion. Poor investment decisions play a part, but mostly if you own quality assets you should not pay attention to short term market prices. Whether it’s a leveraged stock portfolio for $1m+ that somebody sells at a 30% loss in March (I witnessed this multiple times in my office) or somebody dumping, or not buying real estate because of Covid-19 or some other fear, it’s usually panic that causes the loss.

The compounding effect of wealth accumulation via leverage at a young age will make a world of difference in your retirement years.

In spite of this rant I’m usually hesitant IRL to suggest a younger individual pile on the leverage - primarily due to a general lack of understanding and the typical knee-jerk reactions that come along with inexperience. Would welcome a counter-assessment if somebody sees things differently.

Maybe this is true at the ultra end of the spectrum but my parents are in the ~$10M self made net worth category and as happens in life a lot of their social circle is made up of these types as well. So nearly all of the cases I’m most familiar with are small businesses which may also form bias. But in these cases, nearly every single one of the people I know had a phobia of leverage. Ultimately they passed up incremental normal returns but during wipeouts they had the cash to not just survive but gain share and make a couple small but astute investments that paid off long term Buffett style. I used to be in your camp, but having seen it play out I’ve come to understand that point of view. That said, there’s clearly a middle ground, many of them have narrow expertise and prefer control and as such avoided stock markets which handicapped their wealth growth and a bit of leverage would have gone a long way once they were established. So several of the ~$10M cases I know (parents included) could have easily been 2x that IMO using conservative figures if they had not been fighting with one hand tied behind their back. To be fair, had they erred on too much leverage though like many people did in the 2004-2007 era, they would have been wiped out. So less is generally more in my mind but with some caveats.

You’re probably right there with small business owners in general. From my experience with these folks it’s also a very long road from inception to payoff, unless you happen to be in an aggressive growth industry. I’ve seen several cases however where the land/building they operate out of holds equal or more value than the business itself - which of course was purchased with leverage. Broadly speaking, small business owners may feel they are taking substantial risk (and often leveraged the house for seed capital) and so additional borrowing is not seen as overly attractive.

I’ve worked with a few real estate moguls over the years who have acquired $100m+ in equity and they will give a speech on leverage if given the chance. Clearly they’re in the minority, but I think for the majority of the non-entrepreneurial types (myself included) or for those who do not stand to inherit any significant wealth (again, myself included) leverage and risk is the primary method to accumulate capital. It’s just not going to happen even if you’re making decent money and manage to save 20-30% of your earnings. I don’t know what the optimal leverage / income or net worth ratio is, but I haven’t reached it yet.

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broad market leveraged vehicles are safe on account of diversification .

non-diversified, commodity, voaltility, etc are a no-no

I’ll mention it since no one has yet, there’s definitely survivorship bias in that sample of people who used leverage who became wealthy. I’ve been mulling over this a lot lately since I have very little leverage and a really good credit score.


Yeah these leveraged ETFs are a different type of leverage, but leverage nonetheless. I’ve actually steered clear of these in the past because my non-existent knowledge of them told me the embedded re balancing costs will chew away your return over time. Won’t go in to too much detail about these as I understand it’s been beaten dead in various threads. I usually just use my unsecured LOC or margin to leverage individual stock positions.

4X+ leverage in real estate is precisely the reason why so many people think real estate is a safer bet and better investment than equities. It’s the “well I made 200k on my real estate investment in the last 5 years show me that in your stock portfolio” type. Without realizing of course the percentage gain in equities has outpaced real estate but the leverage factor increased their cash-on-cash return by some 10X if they’re high ratio.

HP: For sure there’s some survivorship bias there but I really feel those who are getting blown up are just panic selling. If you own quality income-producing assets, short of a full blown meltdown you’ll be OK in 5 - 10 years.

The full blown meltdown worries me… I agree you’ll likely to be okay but whenever I do something, I always ask why that opportunity exists to me.

For instance, I want to buy some quality income-producing assets and lever them up. If it was that easy, why would the person who owns the quality income-producing asset (who knows the asset way more than I do) not lever up the asset himself and reap the rewards?

I’m not saying the market is perfectly efficient but if you do that, you have to make sure you know something that the person selling it to you and the person providing you the leverage doesn’t know in order to make any alpha.

Maybe you can find a distressed situation, maybe an estate with uninformed descendants, maybe you can value assets better than they do… but you’d have to make sure you have some edge.

That’s what separates the men from the boys!! The majority of people are risk averse. My wife wouldn’t borrow $10 to buy a stock even if it was artificially depressed by 50%. She just doesn’t understand it and “doesn’t like debt”. To some degree that’s the point of my original post. Too many people are flat risk averse and can’t see past the next 3 months, let alone 3 years. These opportunities don’t present themselves too often in equity markets… I’ve been saying all along that I’ve been buying top shelf financial stocks among others at 6% yields, mostly on borrowed funds of which my after-tax cost of borrowing is ~2%. It’s a ridiculous spread with lots of upside potential. If you’re going to leverage anything you have to tuck it away in your mind for several years. Resist the temptation to trade, just buying quality stocks/real estate and holding will pay off and I firmly believe you’ll thank yourself down the road. (Or kick yourself 10 years later because you didn’t do it).

Got ya, “Scared money don’t make no money” like they say!

HP, I’m surprised to see you being such a pansy, real leaders don’t sit around ringing their hands asking questions about leverage and what if’s. I like to ask myself WWDD or what would donald do in these situations. You didn’t see Trump asking himself things like “should I leverage this casino 10x after the last 3 failed”.

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The first thing that comes to my mind when I hear stories about getting rich with leverage is survivorship bias. You very rarely pay attention or hear of those people who lost the farm, you only hear about those who bet the farm and won. For every success story, there’s 10-15 bankruptcies, that’s just the law of probabilities. Unless you see yourself having a clear cut informational advantage and the ability to take on massive volatility, I would advise against taking on a lot of leverage. Slow and steady wins the race in many cases.

Or at least gets to keep the farm.

The rational, mean-variance efficient side of me understands the advantages of leverage; the conservative, child of immigrants side of me sees the disadvantages of leverage. :grimacing:

Leverage is key. Real estate is prolly the best place for it because their cycles are usually 17 years long. Stock market cycles are only 8 years. But leverage for real estate is like 4x the down payment with a 30 year payment period vs the stock market at 50 percent margin at stupid rates of 8 percent for most with the risk of getting called if prices go down. I think you can borrow at Ibkr at about 1.5 percent though. M1 finance at 2 percent. Stock market returns are much higher than real estate. Real estate usually just keeps up with inflation. But due to leverage in real estate your return is multiplied by 4x. Most real estate in Cali have a 0 percent return, it’s all capital appreciation. Anyways I don’t think now is a good time to lever. Sure rates are low but I don’t think now is a smart time to gamble. When you lever, you best be damn sure you are right because it cuts both ways. For real estate it’s a matter of liquidity, for stocks, you need to be really freaking sure. Cuz a margin call be hitting different.
Anyways I like to lever only when rates are low, terms are long, and returns are easy to make. Imo returns aren’t easy to make right now.

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Conservative bunch! Let me know when that Buy flag is waving, Nerdy :stuck_out_tongue:

I’m primarily thinking real estate when I mention leverage. Cap rates aren’t great in this area, but I’m still buying in the 5-ish% range. Positive cash flows and locking in rates during the lowest cycle in the history of the modern world. With a 10+ year hold I’m comfortable with short term real estate fluctuations. My primary risk is tenant job loss… more prevalent now than ever so we have to be picky on who we accept.

The same philosophy could be applied to equities as well. I think SD is a terrible measure of risk in the equity market but it’s primarily used because most people just can’t handle watching their portfolio bounce around. In no way is it a reflection of the strength of the underlying company itself. If you invest in stable companies with strong balance sheets there is very little chance you’ll be sitting on a loss in 10 years. Problem is people over complicate through their own analysis and biases. Basically talking themselves out of a deal.

The major leverage consideration that people miss is a deleveraging strategy over time. The goal should be to amortize your debt. It’s the inverse of a monthly savings plan, which you probably already have in place. You’re just converting your slow drip savings into paying down a lump sum investment today.

I understand everybody’s viewpoint - I just think you’re missing the boat in a major way. Personally I believe slow and steady wins the race to mediocrity and working into your 60s. Unless I’m sitting way out in left field, there’s really never been a better time for leveraged investment - be it real estate or equities.

Did you used to post under MLA?

Lol. Had to query MLA to see who you were talking about. Why, was he also pro-leverage/risk?

… Or was he just an ass-hole like me?

Just Canadian who was relatively coherent and market related topics.

Amortizing debt with positive leverage on cash flowing real estate is one of the secrets to my low stress lifestyle. That and wifing up a high earning HCB.

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