The Power of Leverage is possibly one of the most neglected areas for the average person. However, if you were to look at some of the most successful people around you, one fact will always become very clear; really successful people fully understand the principle of leverage and use it to maximum effect in their life.
Leverage in real life works very much like the “lever principle” in engineering, such as using a crowbar to lift, move or pry open an object. How does it actually work in real life?
Let’s take a hypothetical example just to illustrate the power of financial leverage. Let’s make a couple of assumptions here to strengthen our case. Assume that you had insider information that the stock price of ABC Company is going to take off and go up 100% in 3 months when they announce a new key product. You also know for sure that Real Estate prices are going up 50% in the next 6 months. However, you only have $50,000 spare cash in your bank. Where will you put your money?
When I paint this scenario to a group of people I spoke to sometime back, many of them will chose to invest their $50,000 in the stocks of ABC Company. When asked why this was so, I received various answers such as, “With $50,000, I cannot afford to buy a house, so I’ll put them in stocks!” or “Stocks are more liquid and I will get my money back faster!”. Almost all the time, there will be more people choosing the stock option, especially when they take into consideration that the stock price will double in 3 months when the real estate prices will only go up by 50% in 6 months. And this is the case of how the majority of people will think.
Ask a really successful person this same question and the answer will almost always be to put their $50,000 in Real Estate. How then do I buy a house with just S$50,000 unless I take a loan from a bank? That’s exactly it, take a loan from a bank, a financial institution or your buddy, but regardless, use the concept of OPM (Other People’s Money).
Here is the reason why. When you put the $50,000 in the stock of ABC Company, you will make a 100% return-on-investment when the stock price doubles in 3 months ie your profit is $50,000. However, depending on where you are, you only need to put your $50,000 as down payment for a piece of Real Estate. In some areas, you can put in as low a down payment as 5% to 10%. Let’s conservatively assume that we use 10% down payment. This means that your $50,000 can be the down payment for a $500,000 house. In 6 months time when the price of your Real Estate goes up by 50%, you would have made a handsome profit of $250,000 in just 6 months! If your down payment had been just 5%, you’d have bought a $1M piece of Real Estate and make a profit of $500,000 in just 6mths. The picture becomes a lot clearer when you weigh a profit of $50,000 in 3 months vs $500,000 profit in 6 months. By investing in Real Estate and using the Power of Financial Leverage, your profits is 10 times more despite a percentage price movement of Real Estate of only half that of Stocks.
Why is this so? Well, the reason is that in the case of Real Estate, you have a 20:1 leverage for a 5% down payment (10:1 if down payment was 10%) as compared to no leverage in the case of stocks. In the last few decades, financial instruments such as margin and option trading have become very popular allowing investments in certain selected stocks to be leveraged as well.
The above is an example of Financial Leverage. In daily life, there are 4 other areas of leverage we can capitalize on.
Firstly, there is Time Leverage. In this world, we are all born with different talents. Some are more intelligent, some are better looking while some are taller and some are fatter. However, there is only one thing in life we are all born equally with and that is time. All of us have 24 hours a day and approximately 40 years of working life (from 20 to 60 years of age). It therefore goes without saying that in order to be wildly successful, we must leverage time. A factory production line is a good example of time leverage. One worker can only have 24 hours a day. If you hire 10 workers, you basically have 240 hours a day!
The second is Knowledge Leverage. Successful people almost always don’t know everything. Bill Gates probably does not know what goes on inside his Microsoft Windows programs. He does however, have a great vision and leverage on the knowledge of this team of programmers to develop Microsoft Windows. He leverages on his Marketing Team to market his products. There are hundreds of areas in a company where you need to know about and the successful CEO’s job is to find someone who has the knowledge you can leverage on.
Thirdly, we need to look at the areas of Technology Leverage. Technology allows us to do things faster and with higher precision than ever before. The computer and word processor is a good example of leveraging of Technology. Before the advent of the Word Processor, documents were typed and corrections were done with correction fluid which was slow, cumbersome and untidy. The word processor changed all that and is able to churn out professional looking documents with graphics in less than a quarter of the time it takes a typewriter to do. Product robots are able to assemble a car faster and with better precision than any humans can do. The internet and mobile phone is changing the way we live, work and play and we can all do this in a much more effective way.
Last but not least, we can look at the area of Network Leverage. There is a saying that goes, “It’s not who you know but who knows you!” One can never underestimate the power of networking and “selling yourself and your capabilities”. When successful people have a project on hand and they are looking for the right people to help them achieve their dreams, they will almost always pick those they know to head the top level managers. They may not know them personally, but they will at least know the capabilities and reputation of the people they hire. Similarly, when you are successful and you are need to leverage off others’ knowledge, you’ll look first at the group of people within your existing network.
This article serves to highlight the power of leverage and how it can help you achieve the same level of success as many others. Leverage requires that you go beyond your comfort zone, working with people you don’t know well and thinking of ways you never thought possible. No successful person ever became successful without leveraging. There are many skills to learn in the road to success, but if I have to choose one to be successful, the skill of Leveraging will be top of the list for sure.