YW Blogcast 7 - The ADD guide to leverage

Maybe you think the idea of leverage, when it comes to investing, is sort of boring and the kind of thing only old guys in suits worry about. We’re here to tell you, if you ever want to be rich beyond your wildest dreams of avarice, you better understand leverage.

In case you have Attention Deficit Disorder, are busy cramming for finals, or simply partied too much last night, here’s the short version. Stick it in your brain somewhere where you can get at it in the coming years.

In this example, we’re going to pretend like two surfer dude friends, Bill and Ted, have $10,000 to invest. Bill’s been drinking the Wall Street Kool-Aid and puts his money into an S&P Index fund. Ten years later, his nest egg has grown to $17,000. Nice but not too impressive. That’s less than 10% a year. Where we come from, that’s small potatoes and certainly not going to make you wealthy.

Ted, advanced leverage expert that he is, uses his $10,000 to put 10% down on a house and property worth $100,000. Even in the terrible California market, ten years later his property is worth $159,000. He’s only been making interest payments, which were covered by rent collected from tenants. Ted sells the house, pays off the $90,000 loan, which leaves him with $69,000. Subtract the original $10,000 he used to get started and he’s got a cool $59,000 for his efforts.

Compare Ted’s $59k profit to Bill’s anemic $7k. That, boys and girls, is what leverage is all about.