Historical article note: This article was originally published on 2019-04-04. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
Archimedes said, 'Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.' At the time he said this, people on Earth believed that the Earth was the center of the universe—that is, the geocentric theory. The reason this bold statement has been passed down is not because of the principle of leverage, but because it is full of the passion and ambition of youth. Buffett said, 'Stay away from leveraged financing; no one ever went broke by not taking on debt.' This investment maxim is regarded by many as a gold standard. Rich Dad said, 'Only less than 5% of Americans are rich because only these people know how to use the power of leverage.' This seems to align quite well with reality. In the same way, opinions about leverage have varied throughout history. Obviously, those who use leverage well have become wealthy, while those who use leverage in the wrong place have gone bankrupt. The amount of information humans can pass on through genes is very limited, so after birth, we need to constantly learn from the experiences and lessons of our predecessors. If one wasn’t born with advantages, one must acquire the right knowledge in life to become wealthy. The principle of leverage was discovered and applied more than 2,000 years ago. While leverage benefits humanity, it has also caused many problems for those careless people who don’t know how to use it. The three main ways to create wealth—1. stock and securities investment; 2. real estate investment; 3. running a business—all require leverage. Today, let’s take a closer look at the pros and cons of leverage.
A lever without a fulcrum is just a stick.
The principle of leverage is: effort arm × force = resistance arm × load. The longer the effort arm, the less force is needed. If you want to save effort, it depends on where the fulcrum is placed. In Archimedes' famous quote, the key point is also the fulcrum. So, what is the fulcrum in investment and financial management? I believe savings are the fulcrum; income is the force. Take buying a house as an example: the down payment is the fulcrum, income is the force, and the mortgage is the effort arm; all three conditions are necessary to leverage the large asset that is the house price. In Canada, at least a 5% down payment is required to get a mortgage, which serves as the effort arm. In securities investment, you can also invest on margin; if losses exceed the margin, the investor must either add more margin or close the position to stop the loss. The margin itself is the fulcrum. In entrepreneurship, time leverage is used, paying employees to replicate yourself, and the leverage in entrepreneurship is the wages and benefits provided to employees. If you buy a house without a mortgage, it may take 30 or 40 years to afford; if you buy stocks without margin, you won’t lose everything overnight; an entrepreneur without employees is a sole proprietor and has to do everything personally. For real estate investment or starting a business, it’s best to prepare the fulcrum, otherwise the bank won’t provide the effort arm. I 100% agree with Buffett’s opinion that in securities investment, 'stay away from leverage; no one ever went bankrupt by not borrowing.' Even if you have a fulcrum, it’s better not to use it. Many people are eager to invest without accumulation or savings, and leverage without a fulcrum is just a stick—it won’t create a leverage effect. The beginning of investing is accumulation and delaying gratification.
02 Dreams Ruined by Leverage
Between 1998 and 1999, I worked and studied at Bank of China Group in Hong Kong, and I followed the audit department of a certain bank to inspect the mortgage business of several branches on Hong Kong Island and in the New Territories, especially the files of additional mortgage applications from 1997. In 1997, the optimism about Hong Kong real estate among both clients and banks was like the Toronto real estate market in March 2017: people believed that land was scarce and that trees could grow all the way to the sun. Unlike Toronto, in 1997 before Hong Kong returned to China, Hong Kong people blindly optimistically believed that the Party and the government would not let the real estate and stock markets collapse, so they would use additional mortgages from real estate as margin to invest in stocks. When both the stock and property markets fell simultaneously, the margin in the stock market was forcibly liquidated, the outstanding mortgage exceeded the property value, and the desperate people who had used double leverage began to jump off buildings. I was 29 at the time, and this scene was deeply engraved in my mind: never leverage on top of leverage, especially in the stock market, and never invest with margin. If both the stock market and property market rise simultaneously, there must be a bubble, and when approaching the bubble’s trigger point, the same happened in the U.S. in 2008. Hong Kong property prices fell from the high point in 1997 to the lowest point in 2003, a 70% discount, that is, in 2003, Hong Kong property prices were 30% off. In 2003, Premier Wen attended the Hong Kong return celebration, and he was greeted by a silent march of 500,000 Hong Kong people wearing masks to protest the sluggish property prices. Soon, Chief Executive Tung announced his resignation due to health reasons, and Hong Kong property prices began to reverse, only returning to the 1997 level in 2012, taking 15 years. Those who jumped at that time, if they had held on for 15 years, would have truly suffered. The collapse of a dream of getting rich could very likely ruin a lifetime. Therefore, remember Buffett’s words: 'Stay away from leveraged finance; no one ever went broke by not taking on debt.'
03 Leverage is power
From the negative example above, we can see that using leverage does not change the quality of an investment, but it can double the losses or gains. Leverage is merely an amplifier; good investments must be found on your own, and then the power of leverage can be applied. Financial asset/securities investing involves lending money. When you buy a company’s bonds or stocks, you are essentially giving this company a loan. Once this loan is securitized, it can be traded in the market. The investor’s return comes from dividends or bond yields, as well as the profit from buying and selling this loan. Essentially, financial asset/securities investing is an act of lending with leverage, earning interest or arbitrage profits. If the investor’s money is borrowed, there is pressure to repay the loan while also bearing the risk that the investment may not recover the principal. This behavior is risky, not investing, as it adds credit risk, market risk, industry risk, and interest rate risk. 'Leverage' is neutral; used well, it doubles returns, used poorly, it doubles losses. Looking at the three major ways to create wealth (1. stock and securities investment; 2. real estate investment; 3. running a business), leverage is not suitable for stock and securities investment, financial leverage is suitable for real estate investment, and time leverage is suitable for running a business. Things that cannot be achieved by oneself require leverage, but excessive or hasty use can harm oneself. Leverage is power, but it should not be used to hurt yourself, nor should you be too greedy or impatient; learn to use leverage slowly.
04 Achieving Dreams Through Leverage
Humans are not born with many levers, even fewer than other creatures. Birds are naturally born to fly, but nowadays humans have surpassed birds in flight using levers, relying on the acquired ability, the inheritance of knowledge, and the accumulation of wisdom. Today, traveling from Toronto to Beijing does not require walking to the Pacific coast and swimming across; buying a plane ticket allows one to fly over vast lands and waters even faster than birds. By utilizing levers, we have already achieved many dreams. Can we also realize the dream of retiring young and wealthy? One book in the Rich Dad series, *Retire Young and Retire Rich*, was translated in China as *Rich Dad: Leverage Your Way to Wealth*. The book introduces many useful levers, with the most crucial core concept being: people with levers use other people's money or time to become wealthy; people without levers become levers for others, helping others become wealthy and retire young and rich. Finding your own lever is a self-learning process that should begin immediately after graduating from school. Those afraid of making mistakes might live by the rules their whole life, only to discover after retirement that they made a big mistake—their retirement funds cannot support their retirement life, and the most valuable time wealth in life has already been exhausted, never to return. Many people feel deeply struck after reading these perspectives. Due to my work, I can attest that every word is valuable and absolutely true; this is not just inspirational talk, but a sincere reminder from an awakened person to all readers. I have personally witnessed clients, after mortgaging multiple investment properties, withdrawing cash to pay off their personal home loans, achieving the ability to retire at any time at least ten years earlier.
Since we were born, we have known that there are two kinds of education in the world: 1. Basic and research education; 2. Vocational education. These types of education can only lead us toward being good employees. The most important financial education is ignored by schools. In the industrial era, the pension system guaranteed by employers and the government is collapsing with the advent of the information age. Companies in the information age have shorter lifespans, and overly heavy corporate pension schemes are being abandoned by businesses. Take Canada as an example: all new companies do not participate in DB (defined benefit) pension plans, which guarantee employees a lifetime pension. Companies like Sears, which previously participated in DB pension plans, lost in competition on the one hand, and on the other hand, as the pension burden for retired employees became heavier, ultimately dragged the company into bankruptcy. Imagine a 70-year-old former employee hearing that the company has closed and there is no longer a corporate pension, and they can only rely on a government pension of less than 15,000 per year—would they be able to submit resumes and return to the workplace? In life lessons, one cannot lack "private property investment education," otherwise, it is possible to be someone else's leverage for a lifetime; occasionally using leverage might instead ruin oneself.