Ed Rempel, a certified financial planner (CFP) and accountant, is a regular comment contributor to this blog. He is well known for his strong opinions on using leverage for financial gain. Here is an article that he has written on leverage.
I was browsing through Forbes latest list of the 400 richest Americans and it occurred to me that they almost all made it there the same way. Basically, the ONLY way they made it super-rich is by leveraging into equities!
Only 21 inherited it – the rest made it themselves. Many people might assume there would be celebrities, such as movie stars or athletes, but the only celebrity on the list is Oprah Winfrey. Essentially everyone else made it there by leveraging into equities – or inheriting it from people that leveraged into equities.
Most of them made it there by building a business. Nearly all of them started up a company and borrowed to invest in it. And then their business would borrow a lot more money, which is necessary to grow quickly. Making it rich without leveraging is not really possible.
Of the 400 richest, 37 made it there as mutual fund or hedge fund managers, and 22 are investors – all investing in equities. 28 made it in real estate, but really it was by building a real estate company. Even Oprah Winfrey built a media and entertainment business.
Businesses are equities. Whether they borrowed to invest in one business or many, the ONLY real way to major wealth is by leveraging into equities.
This leads to the obvious question – if leveraging into equities is the ONLY “yellow brick road” to wealth, why don’t more people do it?
The answer is fear – fear of leverage and fear of equities – both of which are partially well founded and partially highly exaggerated.
Talbot Stevens wrote that “Leverage is a power tool”, which describes it very well. Nobody questions that a power saw will cut a board quicker, straighter and cleaner than a hand saw. If you are uncomfortable with power tools, you may be scared to use it – and if you use it badly, you could hurt yourself badly.
Leveraging into equities is the same. You may be scared to do it and if you do it badly, then you could really hurt yourself. But in skilled hands, it builds wealth far more quickly and directly. By leveraging, you can make a lot of money with solid investments. Without leverage, you can only do it by buying very risky investments.
There are also all the facts about how terrible most equity investors. Based on the Dalbar study, the average investor averaged 3.5%/year for the last 20 years, while the funds they owned averaged 11%. Buy an average fund and hold it and you make 11%, but the average return of millions of investors is only 3.5%! Why – because most of us actually believe we can successfully market time.
The entire field of Behavioral Finance is very entertaining. It is all about all the cognitive errors we as humans are conditioned to continually make.
However, there are solid investment strategies. There are exceptional investors that beat the markets by wide margins over time. They constantly study the markets and they all can tell you why they beat the indexes. We call them “all-star fund managers”.
You can get over the fear of equities by having a solid strategy, continually studying the market and constantly resisting human tendencies – or you can just hire some of these “all-star fund managers”.
Leveraging into equities is also the main reason for the power behind the Smith Manoeuvre and the Rempel Maximum.
Bottom line – use leverage skillfully and invest either with or like the all-star fund managers – and you can get onto the ONLY road to wealth.