We all want to work smarter, not harder. When it comes to building wealth, that statement rings especially true. The mission is to make your money work for you (not the other way around.)
Two financial principles can help you reach your financial goals faster: leverage and acceleration. These principles are so indispensable to building wealth that I call them The Law of Leverage and The Law of Acceleration.
What is The Law of Leverage?
A lever allows you to move something heavier than you could lift by yourself. In finance, leverage will enable you to buy something “heavier” than you could with your own money. How? By using borrowed capital or debt to increase the potential return of an investment.
Leverage allows you to do more with less. It takes three things to build wealth: time, knowledge, and money. You can leverage any of these to amplify your returns. For example, if you use your knowledge to record a paid course, you will get paid every time someone purchases it. However, you only had to put in the work once.
How Does the Law of Leverage Work?
One of the most common examples of the law of leverage at work is using a mortgage to purchase a home. First-time home buyers can buy a house for as little as 3% down. So, leverage makes purchasing a $300,000 asset possible with just $9,000 (plus closing costs).
Property appreciates over time. So, let’s say this home appreciated by 10% in the first year somebody bought it. In this case, the home is now worth $330,000. The homeowners gained $30,000 in equity– over three times what they invested into the house. They tripled their investment in just one year!
That’s the power of leverage. If you invest $9,000 into the stock market, you’ll only have $9,900 at a 10% return. It’s better than nothing, but understanding how the law of leverage works helps your money work even harder for you.
Related: 5 Laws Every Wealth Builder Should Know
It’s important to note that the law of leverage is only at work if you use loans strategically to make more money. Otherwise, you are not leveraging— you are going into debt.
What is Good Debt? (Good Debt vs. Bad Debt)
One of the biggest hesitations people face on their wealth-building journey is a fear of debt. This can be a healthy fear as it relates to bad debt, or consumer debt.
People use bad debt to buy things that go down in value, such as liabilities like televisions. On the other hand, people use good debt to buy things that go up in value, such as assets like real estate. A fear of taking out good debt like business loans, mortgages, or, in some cases, student loans, can stop your wealth building journey in its tracks.
The law of leverage uses good debt to control more assets with much less money. It pays to use leverage well. Banks loan you more when you prove you can handle debt responsibly and use it to create wealth. It takes a higher level of financial literacy to operate in the law of leverage. Leveraging well becomes a win-win: the banks will lend you more money at lower interest rates so you can increase your return on investment, and the banks assume a lower risk.
Related: WealthBuilding: 5 Limiting Beliefs That Will Keep You Stuck
Where it Gets Fun: The Law of Acceleration
The Law of Acceleration is a byproduct of The Law of Leverage. The Law of Leverage shows you how to purchase larger investments with smaller loans. The Law of Acceleration allows you to use the same loan to purchase multiple investments.
Here’s how it works in real estate:
1. Let’s say that you have $10,000 to use for a down payment on an investment property.
2. Six to twelve months later, you can do a cash-out refinance on the property and take the original $10,000 back. (A cash-out refinance allows you to take advantage of the equity you’ve built in your home by giving you cash in exchange for a bigger mortgage.)
3. You can rinse and repeat the process to build your real estate portfolio, all with the same initial $10,000 down payment!
