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Leveraging as an Investment Strategy

Leveraging is a strategy that investors use to boost their potential returns by using other peoples money to invest. Investing with borrowed money can be a powerful financial tool that magnifies potential returns and losses. For example, if you invest $10,000 of your own money together with $10,000 of borrowed money into a fund at $10 per unit, and the unit value increases to $12, your investment is now worth $24,000. After you pay back the loan of $10,000 plus interest - for example 5% or $500 - you will have $13,500 left - a return of 35% on the $10,000 you provided for the investment. If the full $20,000 invested was all your money, the return is only 20%. But investors need to realize that losses are magnified as well.

Leveraging works only when the value of investments increase. For example, in the case above, if the value of the units falls to $8, the total investment is worth $16,000. After paying back the $10,000 loan and $500 in interest charges, you have a loss of $4,500 or 45%. However, the value of the total investment fell only 20%.

With leveraging, movements of interest and inflation rates, as well as the actual investment, determine how favourable the outcome will be. When interest rates increase they can increase your cost, which reduces any gains on your investment. However, interest costs are generally tax deductable which reduces the costs significantly.

Here's some tips on leveraging:

Ensure the investments bought with borrowed money are suitable in helping you meet your goals and objectives and fall within your risk tolerance levels. Keep a sufficient financial cushion to see you through any declines. Ensure your cash flow permits you to continue loan payments. Understand the risk of using collateral (ie: family home) as security for the loan. If the lender calls their loan and the value of your investments fall, you could lose that collateral. Understand the tax consequences. The interest paid on borrowed money for investing can be a tax deduction but any realized profit may be taxed.

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