Smart Ways to use Leverage

I'm going to take this opportunity to get up on my high horse, like I like to do on this show, and talk about leverage: good leverage, bad leverage, and everything in between. Leverage can often be seen as a dirty word, but we use leverage in our lives every day. When we buy something on a credit card, when we buy a house with a mortgage, you're using leverage, right?

You have less money and you're borrowing on top of that to buy an asset that's going to hopefully grow in value or that you need. Ultimately, the use of leverage can be very helpful. I've certainly helped investors use leverage where they take a loan out on their traditional portfolio at a lower interest rate than our expected market returns, and we leverage up our equity exposure.

Leverage is also very commonly used when you are investing in alternatives. If you are investing in PE, we talk about buyouts, and we had all these kinds of things in the 80s where the use of leverage was a big deal. The reason a lot of PE and VC and all these other types of products did really well in a low interest rate environment is because it was really cheap leverage, and they could magnify the returns and invest, borrow at a low rate, and invest with a higher expected return, and therefore get you more return and more juice in your portfolios.

Using leverage to include and manage risk can also be really helpful. I talked about long short funds. When you go long a stock and then you short, you're using leverage to short. The short can be your risk management in many ways so that you can put more money in the stocks that you have high conviction of. Return stacking is the same idea.

I like to use leverage as a way to have cheap borrowing and take what I'm borrowing and put it into a higher expected return opportunity.