Leverage means using borrowed money to magnifies your results — both gains and losses. If your base investment performs well, leverage accelerates your returns. If it performs poorly, leverage accelerates your losses even faster.
1. Why Leverage Works
Leverage simply allows you control , and deploy more assets than you actually own (i.e borrow and invest).
Example: You have ₹1 lakh and borrow ₹3 lakh at 10% interest. Total capital invested = ₹4 lakh.
If your investment earns 15% => you make ₹60,000 in profit => You pay ₹30,000 interest.
Your net gain = ₹30,000 on ₹1 lakh of your own money (equity) → 30% return.
You earned 15% on the asset, but 30% on your equity — doubled the outcome due to leverage. Leverage can be a great tool when borrowed capital is cheap.
2. Why It Turns Dangerous
Now flip the scenario. Suppose the investment return falls to 5%. Your profit is only ₹20,000, but you still owe ₹30,000 in interest.
Your net result = –₹10,000. Your ₹1 lakh capital is now worth ₹90,000 → –10% loss.
Same tool, different outcome — leverage amplifies pain just as efficiently as profit.
3. Common Real-Life Leverage
- Home loans: You borrow to buy a property expecting price appreciation. Works only if appreciation > loan rate + costs.
- Business leverage: Companies borrow at fixed rates to earn higher returns on capital employed. Works until sales slow down.
- Stock margin trading: Looks smart when markets rise; ends careers when they fall.
4. The Leverage Multiplier Effect
Even small changes in return have huge effects when leverage is high.
| Return on Asset | Interest Cost | Leverage (×) | Return on Equity |
|---|---|---|---|
| 15% | 10% | 3× | 30% |
| 12% | 10% | 3× | 18% |
| 10% | 10% | 3× | 0% |
| 8% | 10% | 3× | –6% |
| 5% | 10% | 3× | –10% |
That’s how leverage silently multiplies both directions — every +1% or –1% in performance becomes a multiple of your leverage ratio.
5. Mental Model: The Double-Edged Sword
Leverage behaves like a double edged sword — if careless will become fatal to ourself..
It doesn’t create value; it only concentrates outcomes. The real trick is not “how much to borrow,” but “how much failure can I survive?”
6. Final Takeaway
“Leverage is the financial equivalent of acceleration — it takes you where you’re going, just quicker — the direction still depends on your driving.”