Stock Market Wealth
Become A Wealth Machine
“Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” – Archimedes
I ask you, where is the fine print? I guess Archimedes failed to add the usual disclaimer that we see nowadays.
Warren Buffett probably coined the disclaimer for him in the best way:
“When you combine ignorance and leverage, you get some pretty interesting results.” The first quote touches on the reward side of leverage, and the second on the risk side.
That about says it all. One was a brilliant mathematician, and the other is the richest man to ever live. Together, they point out the timeless truth about leverage. I believe that if the three of us would sit down for coffee and I’d say “guys, I think I have a way of combining both quotes into one simple line,” they will certainly smile and say “go for it.” Well, here it is:
“Beware of doing big things in a small way.” This simple warning could have saved us all from the 2008 crisis and the late 1990s dot-com crash, for example.
It is a recipe for disaster when combining ignorance with enthusiasm and ambition. Teenagers, for instance, are arguably the most over-leveraged, under-achieving age group. When you are a teen, you usually lie without even giving it an extra thought (relationship leveraging), drive after drinking, work after a sleepless night (physical leveraging), cheat at school exams, curse, act rude without imagining the consequences (moral leveraging), sometimes develop a drug addiction, all the while believing that this COULD GO ON. Teenagers aren’t doing this on purpose; their goal is to enjoy life and fulfill their needs for acceptance, love, appreciation, and new experiences and adventure like the rest of us, but they don’t know (usually) how to get it done (obviously, I am generalizing). This is doing big things in a small way – taking on more than you can handle in order to “live fully.” The danger is the inevitable effect of all the causes they have spent years putting in place. Once they get hit from all the mistakes they made, they are forced to accept the fact that leverage had been misused, or they are doomed to repeat their errors. Sometimes the blow is so hard that it completely changes the individual. We often hear about a teen who was on the streets committing crimes and now is a devoted policeman. Leverage can really play tricks on you. Some financial gurus lost so much money in 2008 that they committed suicide. We don’t want to see anyone losing their sense of proportion about what life is all about and what truly matters. In my opinion, it is that characteristic in a person that causes him to over-leverage in the first place. Over-leveraging is the result of trying to achieve more than you believe you can. In other words, inferiority complex.
In our own lives, we must learn to do small things in a great way, so that bigger things will be entrusted to us to do. Then, we can do those bigger things in the big way. That is success. That helps sleeping at night. Warren Buffett does use leverage. We can use leverage, too. In itself, leverage isn’t a bad thing, but like we have seen, if used in the wrong manner, it is a destroyer. In real estate, a wise investor can use leverage to enrich himself. Here is an example: say you decide to purchase an investment property in Phoenix. You run the annual operating data that includes the rent income, major expenses, water and sewer, property management fees, lawn and maintenance, and insurance and taxes. That means that you have now calculated the gross cash-flow. Now, what determines your yield is two things:
Let’s focus on financing. How would you earn a higher yield? If you paid cash or if you used financing? When done right (a big thing in a big way), leverage would increase your return by as much as 300% sometimes. A proper deal would create a deal flow where the rents would cover all the operating expenses, along with the principal and interest payment. A great deal would even allow for a positive cash-flow after all expenses are paid for. That means that you control 100% of the upside if the property appreciates in price, and the rents cover the financing aspect, including the interest payment. Talk about leveraging other people’s money! If you are truly conservative and defensive, make sure that your numbers work even with 10 months of rents, allowing for vacancy, if that happens. You can readily see the risk here. You have probably put down 20% of the price and financed 80%, so not meeting your obligations would cause a foreclosure and the loss of credit and your down-payment.
How can you speed up the learning curve, then?
I want to end this article by letting you know how I know I am on the right track. I feel out of my comfort zone. That’s how. I grow. Join me and leave the comfort of what is your current reality for a better future. Do everything you do in a big way, and opportunities will seek you out without cease.