What is Leverage?

Leverage.

What is it, and what does it mean for you? Besides the TV show (which I have heard was quite entertaining and enjoyable), leverage plays a critical role in the stock market, economy, and your personal financial situation. In the aftermath of the financial crisis of 2007-2008, the word leverage took on a very negative connotation — banks had used large amounts of leverage to generate large profits during the housing boom in the early 2000s. We all remember what happened next: housing prices began to tumble, mortgages soured, and the financial system nearly brought the economy U.S. to a standstill.

But, is leverage all bad?

Leverage, for all intents and purposes, is simply when people or organizations utilize debt in order to purchase items that they would not be able to purchase otherwise. Auto loans, mortgages, and even credit card debt are all forms of leverage. Leverage, then, is not inherently bad or harmful to people of business, but like most other things, it all depends on how it used. When used to finance the purchase of long-term assets, or properties that will be used to fuel long-term growth (for companies), or financing the purchase of automobile or home (for individuals), leverage can be a very useful and practical tool.

Debt however, if left unchecked, can often take on a life of its own, and so it is important to always remain vigilant in the monitoring of debt and leverage levels. Let’s look at a short checklist put together by your truly:

Leverage – for individuals

1) Review your total debt levels
2) Determine what the debt was incurred for
3) Write down a plan to pay down the debt
a. This doesn’t have to happen overnight, but a plan will help

Leverage – for firms

1) How much debt does the entity have overall?
2) How much of the debt is long-term versus short-term
3) What is the firm using the debt for?

Happy Reading!

http://www.investopedia.com/terms/l/leverage.asp

http://www.bloomberg.com/news/2012-07-17/good-leverage-bad-leverage-and-bain.html

http://www.investorwords.com/2786/leverage.html

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/10294550/Raising-banks-leverage-ratio-will-do-more-harm-than-good.html