What is Leverage?

Leverage means using borrowed money to increase the size of an investment beyond what you could afford with your own funds. A leveraged investor is effectively placing a larger bet than their own capital would allow, with the expectation that the returns will more than cover the cost of borrowing.

A simple example

You have $10,000 and borrow another $10,000 from your broker to invest $20,000 in total. If your investment grows 20%, your portfolio is worth $24,000. You repay the $10,000 loan, leaving you with $14,000, a 40% return on your original $10,000. Without leverage, the same 20% gain would have left you with $12,000.

What happens when things go wrong?

The same mathematics works in reverse. If your $20,000 investment falls 20%, your portfolio is worth $16,000. You repay the $10,000 loan, leaving you with $6,000, a 40% loss on your original capital. A large enough fall can wipe out your entire investment, and in extreme cases leave you owing money beyond what you put in.

Where does leverage appear in investing?

Margin accounts allow investors to borrow from their broker to buy more securities. Some ETFs and funds use leverage internally, aiming to deliver two or three times the daily return of an index. Derivatives such as options and futures are inherently leveraged instruments.

Should beginners use leverage?

No. Leverage is a tool for experienced investors who fully understand the risks and have strategies in place to manage them. For beginners, the priority is to understand markets, build a sound portfolio, and develop the discipline to hold through volatility. Adding borrowed money to that picture before you are ready is one of the quickest ways to suffer a serious and permanent loss.