In plain words: The use of borrowed capital (debt) to increase the potential return of an investment.
Leverage describes any technique where borrowed money is added to your own capital to take a larger position than your savings alone would allow. The idea is simple: if a position rises in value, the gains apply to the whole amount, not just the part you funded. The catch is that losses are amplified in exactly the same way, which is why leverage sits at the riskier end of the investing spectrum.
How does leverage amplify both gains and losses?
Because returns are calculated on the full position rather than your own contribution, a small price move becomes a large percentage swing on your capital. A modest drop can wipe out a leveraged stake entirely, and you may still owe the borrowed amount. This two-way amplification is why leverage raises volatility for the investor.
Why is leverage usually unsuitable for beginners?
Borrowing to invest introduces interest costs, forced selling, and the risk of losing more than you put in. For a long-term, diversified approach built on broad asset classes, leverage rarely fits. A typical educational portfolio favours patience and diversification over borrowed amplification.
Key takeaways
- Leverage uses borrowed money to enlarge an investment position.
- Both potential gains and potential losses are magnified.
- It carries interest costs and the risk of losing more than your stake.