Leverage

‘Leverage’ is a US term that is also known as ‘gearing’. Both express the extent to which any transaction (for example, a house purchase, private equity acquisition or a carry trade) is financed by debt from lenders as opposed to capital provided by the investor.

For example, if I only have £1 of my own cash to invest and my investment doubles I get £2 back, a 100% profit. However, suppose I had borrowed another £9 in the first place and invested this plus my own £1 in the same project. This time, if the investment doubles to £20, I can repay the £9 loan and keep £11, a 1,000% profit.

The danger with leverage, however, arises if things go wrong – had the investment fallen to zero I would be down £1 of my own cash in the first example, whereas in the second I would have lost my £1 and still owe a bank £9.

• See Tim Bennett’s video tutorial: Three ways leverage can boost your returns.

Merryn

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