Adding leverage increases your risk, but increased risk is one way to possibly gain better returns. There are many ways to gain leverage, from using loans, to options, to futures.
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A fundamental question is how much leverage you want to use. Brokerages make it all too easy to over-leverage. I usually use a leverage ratio between 1.3 - 2. For example, if I have $100k cash, I may use that to invest a notional value of $130k in a diversified portfolio.
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A fundamental question is how much leverage you want to use. Brokerages make it all too easy to over-leverage. I usually use a leverage ratio between 1.5 - 2. For example, if I have $100k cash, I may use that to invest a notional value of $150k in a diversified portfolio. A typical hedge fund might use a leverage ratio up to 5, so this is not exceedingly risky.
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People use leverage all of the time for home loans, and it is not unheard of to use a 80% loan to value ratio for a mortgage, or a leverage ratio of 5. For a $500k home, you might put up $100k cash and take a $400k loan. You would likely do this at a reasonable interest rate, and your hope is the value of the home goes up faster than your interest charges. Your home value could fall, leaving you with a mortgage that is underwater, i.e. you owe more than the home is actually worth. All of this can apply to investing as well.
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People use leverage all of the time for home loans, and it is not unheard of to use a 80% loan to value ratio for a mortgage, or a leverage ratio of 5. For a $500k home, you might put up $100k cash and take a $400k loan. You would likely do this at a reasonable interest rate, and your hope is the value of the home goes up faster than your interest charges. Your home value could fall, leaving you with a mortgage that is underwater, i.e. you owe more than the home is actually worth. You could also lose your home in a disaster. All of this can apply to investing as well.
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A typical company might use a loan to ultimately produce something worth more than that loan, in a sense making a leveraged bet. You could argue companies would not exist without such leverage. If you acknowledge leveraging exists throughout the economy, then why not use it to your advantage in your personal finances as well?
The following book provides a good argument for using leverage. The general idea is use high leverage when young and reduce that leverage towards retirement: