Homemade leverage

Homemade leverage  

Within the domain of investments, the notion of leverage occupies a position of utmost significance. Leverage involves the strategic utilisation of borrowed capital to magnify the potential gains from an investment. Yet, within this landscape, an intriguing and distinctive facet emerges, known as “homemade leverage.”  

Though the term might initially appear unconventional, its principles are firmly grounded in the fundamental understanding of leverage. In the following discussion, we will look at homemade leverage, systematically uncovering its intricacies, mechanisms, merits, drawbacks, and tangible instances. 

What is homemade leverage? 

Homemade leverage is a strategic approach used by individual investors to replicate the effects of traditional financial leverage without directly borrowing funds from external sources. In simpler terms, it’s a way for investors to increase their potential returns and risk exposure within their investment portfolio by adjusting their asset allocation, rather than taking on external debt. 

Traditional leverage involves borrowing money to invest, with the aim of magnifying potential profits. However, it also comes with the added burden of interest payments, potential collateral requirements, and the risk of higher losses. Homemade leverage seeks to achieve similar outcomes without these external factors. 

For example, consider an investor who wants to amplify his potential returns. Instead of borrowing money, he might allocate a larger portion of his existing capital to higher-return, higher-risk assets. This increased exposure to high-potential investments can lead to greater profits if the investments perform well. However, it’s important to note that this approach also increases the risk of larger losses if the investments perform poorly.

Understanding homemade leverage 

Homemade leverage represents a creative strategy where individual investors endeavour to replicate the impact of leverage within their investment portfolios without resorting to direct borrowing. Unlike conventional leverage, which involves securing funds from external entities like banks or financial institutions, homemade leverage relies on the ingenuity of the investor to engineer outcomes akin to those achieved through leverage. 

Leverage recap 

Leverage, in general, involves using borrowed funds to magnify potential returns. It’s a common strategy in various financial transactions, such as real estate purchases or trading on margin in the stock market. The idea is to put up a fraction of the total investment as your own money and borrow the rest. If the investment performs well, the returns are calculated on the entire investment, not just your initial contribution. However, if the investment goes south, losses are similarly magnified. 

Homemade leverage mechanism: 

Homemade leverage operates in a similar vein, but with a unique twist. Instead of directly borrowing external funds, investors rearrange their existing resources to achieve a similar leveraged effect. Here’s how it works: 

  • Asset Allocation: Investors start by adjusting the distribution of their existing investments. They allocate a larger portion of their funds to higher-risk, potentially higher-return assets like stocks or other investments with significant growth potential. 
  • Potential Upside: By concentrating more of their capital in these high-potential assets, investors aim to magnify their potential gains. If these investments perform well, the overall return on the entire portfolio is boosted. 
  • Risk and Downside: However, it’s crucial to note that this approach also increases the exposure to potential losses. If the chosen high-risk assets decline in value, the losses will likewise be amplified. 

Working of homemade leverage 

The process of generating leverage using personal resources is deceptively simple yet profoundly influential. Investors achieve this by purposefully adjusting their allocation of assets to harmonise with the principles of leverage.  

To explore this concept more profoundly, picture an investor who possesses a certain sum of capital but desires an exposure equivalent to double that amount. Rather than pursuing external borrowing, the investor might opt to channel a larger portion of his capital into more dynamic and potentially high-yield assets. This calculated manoeuvre not only magnifies the potential gains but also heightens the corresponding risks of the investment, mirroring the outcomes seen when utilising borrowed funds. 

Advantages and disadvantages of homemade leverage 

Homemade leverage bears its own set of advantages and disadvantages. One primary advantage is the autonomy it offers to investors. Traditional leverage often comes with stringent terms, interest payments, and potential collateral requirements. Homemade leverage, on the other hand, eliminates these external dependencies, granting investors more control over their investment strategies. 

Conversely, homemade leverage is not without drawbacks. It accentuates the investor’s risk exposure. The augmented allocation to high-return assets might also magnify potential losses. Moreover, the strategy necessitates meticulous monitoring and timely rebalancing, which demands substantial attention and effort. 

Examples of homemade leverage 

Imagine an investor with US$ 0,000 in capital. Instead of borrowing an additional US$10,000, the investor allocates US$15,000 towards high-potential equities. If these equities appreciate by 20%, the return on the total US$15,000 investment would equal a 30% return on the initial US$ 10,000 capital. This outcome emulates the effect of leverage without resorting to external borrowing. 

Frequently Asked Questions

Homemade leverage in pension plans involves adjusting asset allocations within the portfolio to simulate the leverage’s potential benefits without actually borrowing funds. For instance, a pension fund might strategically allocate more assets into growth-oriented investments to enhance potential returns. 

The mechanics involve reallocating capital within an investment portfolio to mirror the outcomes of traditional leverage. By increasing exposure to higher-yield assets, investors aim to replicate leveraged results. 

Components of homemade leverage include margin trading, options and derivatives, real estate leverage, entrepreneurial risk, and personal investment. Homemade leverage has the potential to increase profits while also increasing risk, necessitating rigorous management and risk analysis. 

Calculate homemade leverage by comparing the actual capital allocation to a theoretical, leveraged allocation. The difference illustrates the extent of leverage simulation. 

Effective monitoring and rebalancing are paramount. Regularly assess portfolio performance, risk tolerance, and market conditions. Adjust allocations accordingly to maintain desired leverage-like outcomes. 

Related Terms

    Read the Latest Market Journal

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 18 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 71 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 111 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 36 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 65 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 88 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 197 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Weekly Updates 12/2/24 –16/2/24

    Published on Feb 13, 2024 70 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com