Want to get rich quick? One of the most powerful techniques for building wealth quickly is to use leveraging. In simple terms, leveraging can be thought of as using other people’s money as well as you own to increase your investing power. Perhaps the most common way of leveraging is to purchase an investment property by taking out a mortgage. Here is how it works. You have $ 20,000 to invest. Obviously, you can’t buy a house with $ 20,000 but you can use the $ 20,000 as a deposit on a house worth $ 200,000 and borrow the remaining $ 180,000 at an interest rate of, say 6%. Let’s say your investment property produces a gross return of 10% a year in rental income and capital gain – that’s a total of $ 20,000 – and you have expenses of interest, rates, insurance etc of $ 15,000 a year. Your net return is therefore $ 5,000, which is an annual return of 25% on the original $ 20,000 you invested!

The reason this works is quite simple – the return you achieve on your investment asset is higher than the cost of borrowing. So if it is that simple, why aren’t there more wealthy people? The reason is that leveraging is a double edged sword. It is not always possible to establish beforehand whether the return on your investment asset will be greater than the cost of borrowing. If it isn’t, then instead of magnifying your gains you will magnify your losses. Going back to our example, if the gross return on the investment property is 6% or $ 12,000 and expenses are $ 15,000, your will lose $ 3,000 or 15% of your original investment.

One of the advantages of leveraging is that if you borrow for the specific purpose of purchasing an income-producing asset, the interest cost is generally deductible against the income.

While it is widely known that this applies in the case of an investment property, it is not so commonly known that it also applies to other assets such as shares. For example, interest costs relating to a mortgage taken out on your home for the specific purpose of purchasing a share portfolio can be tax deductible. There are various forms of leveraged investments available. Endowment warrants and hedge funds are two examples which are increasing in popularity.

Leveraging is an investment strategy with potentially high returns but also high risk. Whether or not it is an appropriate strategy for you depends on your risk tolerance and your overall financial situation. The more certainty there is around the relationship between the investment return and the borrowing cost, the less the risk. Before you embark on a leveraged investment, you should estimate the likely returns under a number of different scenarios – best case, worst case and expected. That way, there will be no surprises.