leverage
The use of borrowed money to amplify potential returns (and potential losses) from an investment.
Example
“The real estate investor used leverage by putting 20% down and borrowing the rest.”
Memory Tip
A LEVER amplifies force — a little effort moves a big weight. Financial LEVERAGE amplifies returns (and losses).
Why It Matters
Understanding leverage is crucial because it can dramatically increase both your profits and your losses. Using borrowed money to invest means you can control larger positions than your actual cash allows, but if investments decline, you lose money faster and may owe more than you initially invested.
Common Misconception
Many people believe that leverage only amplifies gains and overlook the amplified losses. In reality, leverage is a double-edged sword that magnifies both positive and negative returns equally, making it much riskier than investing only with your own money.
In Practice
Suppose you have 10,000 dollars and want to buy stocks. Without leverage, you buy 10,000 dollars worth of stock. With 2-to-1 leverage, you borrow 10,000 dollars and buy 20,000 dollars worth of stock. If the stock rises 10 percent, you gain 2,000 dollars on your investment, doubling your return. However, if the stock falls 10 percent, you lose 2,000 dollars and still owe the borrowed money, potentially wiping out your entire initial investment.
Etymology
From 'lever' — using a lever to amplify force. In finance, leverage amplifies financial force.
Common Misspellings
Start investing with no commission trades
Related Terms
More in investing
Other investing terms you should know
Need financial definitions?
Clear definitions for 2,500+ finance, insurance, and investing terms.