Perhaps one of the most important concepts in building wealth is that of leverage. Leverage comes in many forms but the overall concept is that wealth is created at a much faster rate when other people’s time (OPT), other people’s money (OPM) and other assets are working on our behalf. Leverage truly is the greatest wealth building tool.
More specifically, your ability to create wealth grows exponentially when the time that you personally have during a day to work and create wealth, call it 12 hours, is being amplified by having ‘assets’ you own generating income for you at that same given time.
Embracing the concept of leverage
In my pursuit of creating what I believe is a wealth building blueprint, I am certain of one thing. I don’t think you can build REAL wealth in the shortest period of time without understanding and fully utilizing leverage.
Don’t get me wrong. I think you can create financial security and be on solid financial footing, I just don’t believe you can create real wealth. The type of wealth that lets you become financially independent in the shortest period possible. To get this latter type of wealth, you need leverage.
In order to fully understand leverage and how it’s applied, you first need to recognize the total opposite of leverage. Not having any! The best example of having no leverage in my mind is to have no other income stream than a job where you work for someone else. This is the epitome of a ‘no leverage’ situation.
Working for someone else is the opposite of wealth building leverage
When you work for someone else, those hours that you spend working are effectively ‘single purpose’ hours, in that they are strictly appropriated to your employer. Your hours are generating wealth solely for your employer. In exchange, you are paid for those hours in the form of a wage which is at a rate much less than the value you are capturing for your employer on the service you provide to him/her.
Although you are being ‘compensated for your time’, however, you have NO leverage. Your time is being expended in a linear fashion where you only get paid once for the effort you put in for those given hours and at the level of compensation that is determined by someone other than you.
I view leverage as being on three different levels:
(1) Level 1 Leverage – Is to own something that you don’t have to do anything to monitor or spend time on after you create or purchase it but it still generates income for you even when you’re not in its presence.
(2) Level 2 Leverage – Having an asset that you have to manage but which still generates income for you when you’re not in its presence.
(3) Level 3 Leverage – Things that you have to create, manage or exchange that add value in the marketplace disproportionately to the time and money that you expend on them.
So what would be an example of Level 1 Leverage? The best example would be owning paper assets like stocks, bonds or Index Funds. The reason that these are ‘first level’ leverage is that these really are as passive an asset class as possible.
More specifically, you don’t need to spend your time in order to work on them to generate income nor do you need to oversee them. They generate income on your behalf without you having to do anything and more importantly, they generate income while you are working at your day job effectively ‘leveraging’ your time.
Do something once – Benefit many times over
Another example of first level leverage is creating an asset where all the work is done upfront once and this ‘asset’ continues to generate income over a long term. Although there have been examples of this in the pre-Internet days, such as an author writing a book, there are dozens of examples in the current Internet world that we live in.
Some examples of such assets being successfully created are digital products, online courses, affiliate marketing, and platform revenue from sources such as YouTube.
Level 1 Leverage is the most desirable form of leverage, especially paper assets. For example, having $5 million dollars in the S&P 500 Index would allow for a 4% annual draw of $200,000. For most of us, generating that amount of annual income would be a crazy amount of money even if we DID work for it. To consider that we would have that annual income at our disposal WITHOUT having to have worked for it is amazing!
To a lessor degree, having an already created asset being able to generate even a modest amount of money, say $10,000 to $20,000 a year for us, without having to do expend any additional time to generate it (less time spent on our website and fulfillment system) would also be equally incredible for most of us.
The gift that keeps on giving
Level 2 Leverage is not perhaps as desirable a form of leverage as Level 1 Leverage on the surface, because there is some worked involved, but it has its advantages. The best example of this form of leverage is a rental income property.
More specifically, let’s assume that you own a multi-unit residential income property. You only have to buy it once and other than the infrequent maintenance that is required, it generates income for you literally ‘while you sleep’. As the owner of the asset, your tenants pay you a fee to ‘use’ that asset.
Level 2 Leverage also has another layer of leverage built into it that the other forms of leverage don’t have. The person who owns the multi-unit property, all real estate assets in fact, get to control 100% of that asset for only 20% down payment.
That is leverage in its finest form! Although some would argue that there’s an ability to buy stocks on margin (reserved for experienced and investors with higher net worth) the ability is there for all of us to control income generating real estate for a fraction of the overall purchase price.
Business Assets – Structural elements of building wealth
Level 3 Leverage assets are best represented by business assets. A business allows an individual to create a vessel whereby products and services of value generate income at a higher level than the costs that are required in order to create them in the first place. Similar to Level 2 Leverage assets, other people’s money (OPM) can be used in the utilization of building wealth. This is done by way of a business loan or equity from an investor.
In addition, another layer of leverage utilized in a business is the use of other people’s time (OPT) manifested by hiring other people to work on your behalf. Where you personally only have 8 hours in any given day in which to work, hiring 5 other people can leverage 40 extra hours working on your behalf during that same given day. Think about it! An entire week of work in just one day! Now that’s Leverage!
Businesses leverage a variety of resources
The other aspect of the business asset class is that businesses by their very nature leverage raw materials, labor, their brand, market conditions and opportunities to create ‘margin’.
Margin of course is the mark up that is created from the difference between what something is sold at and what it cost to make. This margin is effectively ‘created’ by the business and essentially is formed from not only the value of the raw materials and labor to work it into a ‘good or service’ but also the perceived value of the brand in the marketplace.
This perceived value of the brand in the marketplace helps create the spread between the sales price and the ‘cost of goods’, otherwise creating the margin. Not all high-priced products have a high margin per se but those brands that enjoy a high premium such as Lexus, Mercedes, Tiffany’s, etc. have created it on the value of their brands. This is leverage at work, pure and simple!
Conclusion
Now let’s go back to the beginning. In order to build wealth…REAL wealth… you need to deploy leverage. As we discussed, if you don’t use leverage you are left to building wealth in a linear fashion…one unit of work applied for one unit of compensation gained. You might get there but it certainly is going to take you a LONG time. With leverage, however, you can ‘bend’ the curve by exponentially accelerating the growth of wealth and therefore compressing the time in which to get there.
The other obvious thing is that using leverage changes the complexity of your time. Instead of your time being spent in the direct creation of the compensation, “trading time for dollars”, when utilizing leverage you are spending your time ‘managing’ assets that create compensation.
When you spend your time managing, you can now oversee multiple assets that are generating income. THIS is where true leverage comes into play!
So if you are looking for just ONE wealth building principle…I believe it HAS to be leverage!
