Leverage in Investing Explained: Why Borrowed Money Magnifies Losses and Can Destroy Wealth

Introduction: The Seductive Promise of Leverage

There is a phrase that appears frequently in investing conversations: "Use other people's money." It sounds clever, almost like a secret that successful people know and everyone else is missing. The idea is simple: if you can borrow money at a low cost and invest it at a higher return, you keep the difference. Your own capital goes further. Your returns multiply.

This is the promise of leverage.

Leverage, in its simplest form, means using borrowed money to invest. Instead of only investing what you have saved, you add funds from a broker, a bank, or another lender. If your investments rise, you profit not only on your own money but on the borrowed money as well. It feels like a shortcut, a way to accelerate wealth without waiting decades for compounding to do its slow work.

But leverage has a quality that is easy to overlook when markets are rising and optimism is high. It does not discriminate between gains and losses. The same mechanism that magnifies your profits also magnifies your mistakes. A decline that would be painful but survivable without leverage can become catastrophic with it. And because borrowed money comes with rules, deadlines, and lenders who demand repayment, leverage removes the one thing investors need most when things go wrong: time.

As of late 2025, margin debt—money borrowed by investors to buy stocks—reached record levels exceeding $1.2 trillion. This is not a distant Wall Street phenomenon. It reflects how widespread borrowed-money investing has become, reaching everyday investors through apps and leveraged products. Understanding leverage is no longer optional for anyone who wants to invest wisely.

This tutorial is an invitation to slow down and think carefully about leverage. Not from a technical perspective filled with formulas, but from a human perspective rooted in how real people lose money. The goal is not to scare, but to explain clearly why leverage is far more dangerous than it appears and why most investors should avoid it entirely.

Understanding How Leverage Works

Leverage simply means using borrowed money to invest. The effect is straightforward: it stretches whatever happens to your investment.

Suppose you have $10,000 of your own. Without leverage, a 10% gain gives you $1,000. A 10% loss costs you $1,000.

Now suppose you borrow another $10,000, giving you $20,000 to invest. A 10% gain becomes $2,000 on your original capital—a 20% return. A 10% loss costs you $2,000—a 20% loss.

The investment moved the same 10% in both directions. Leverage simply doubled the impact on your money.

This stretching effect grows with more leverage. Borrow $30,000 against your $10,000, controlling $40,000 total, and a 10% decline wipes you out completely. The math is unforgiving.

Leverage does not create new opportunities. It only makes gains larger and losses larger. And because losses in investing are inevitable, leverage eventually turns manageable setbacks into permanent damage.

The Dangers of Amplified Losses

Mistakes in investing are not unusual. They are inevitable. Even the most careful investors misjudge businesses, misread economic conditions, and underestimate risks. The difference between a mistake that is painful and a mistake that is permanent is often leverage.

Without leverage, a mistake usually results in a loss that is manageable. You lose money, you learn, you adjust, and you continue. With leverage, the same mistake can permanently damage or completely wipe out a portfolio.

Consider a simple example. Suppose you invest $50,000 of your own money into a single stock. The stock declines by 30%. Your investment becomes worth $35,000. You lost $15,000. This is unpleasant, but you still have capital left. You can reassess, learn, and continue investing.

Now suppose you instead invest $50,000 of your own money and borrow $50,000 to invest $100,000 total. The same stock declines by 30%. The investment becomes worth $70,000. You still owe $50,000. You are left with $20,000. You lost $30,000, which is 60% of your original capital.

The stock did not collapse or go bankrupt. It merely experienced a decline that, while significant, is not unusual in markets. The leverage transformed a difficult experience into a near-crippling one.

This is the core danger. Leverage does not require extreme outcomes to cause extreme damage. It only requires ordinary volatility.

The Brutal Math of Recovery

One of the most dangerous aspects of leverage is that losses compound faster than gains, and the math of recovery becomes punishing.

If you lose 10% of your capital, you need an 11% gain to break even. That is manageable.

If you lose 30%, you need a 43% gain to recover. That is harder.

If you lose 50%, you need a 100% gain just to get back to where you started. That is where progress stalls for years.

Leverage pushes losses deeper. A 30% decline on a leveraged portfolio might translate into a 60% loss of your own capital. Now you need a 150% gain to recover. That is not a setback. That is a restart, if you have anything left to restart with.

The distance between "I made a bad call" and "I am financially ruined" is much shorter with leverage.

How Leverage Destroys the Investor's Greatest Ally—Time

Time is one of the greatest allies an investor can have. Without leverage, a patient investor can wait through market downturns, allowing businesses to recover and valuations to normalize. A stock can fall 40% and take three years to come back, and the unleveraged investor who simply held is whole again.

Leverage takes time away.

When you borrow money to invest, you are bound by rules, deadlines, and risk thresholds imposed by lenders. You cannot simply wait forever. If prices fall too far, your lender will demand action. This is not a matter of negotiation. It is built into the agreement.

Unleveraged investing benefits from long time horizons. Leveraged investing requires short time horizons. That single distinction explains why leverage is fundamentally incompatible with patient, long-term wealth building.

Understanding Margin Calls in Plain Language

When you borrow money to invest, your broker requires collateral. Your own invested capital serves as that collateral. The broker monitors the value of your account constantly. If your losses grow large enough, the broker becomes concerned that you may not be able to repay what you borrowed.

At that point, you receive a margin call.

A margin call is a demand for more money. You are typically given two options:

1. Deposit additional cash or securities to restore your account's safety level.
2. Allow the broker to sell some of your investments to reduce risk.

If you cannot provide additional funds quickly, the broker will sell assets without asking for your permission. This is not hypothetical. It is standard operating procedure.

Forced Selling at the Worst Possible Time

Forced selling is one of the most destructive consequences of leverage. It almost always occurs during market downturns, precisely when prices are already depressed and fear is widespread.

Imagine this scenario.

You invest $100,000 using $50,000 of your own money and $50,000 borrowed. A market correction occurs, and your investments fall to $70,000. Your broker determines that your equity is now too low relative to your borrowed amount. You receive a margin call.

You do not have spare cash available. The broker sells $20,000 worth of your investments at current market prices.

Now:

1. Your investment value becomes $50,000.
2. You still owe $50,000.
3. Your account is essentially wiped out.

Even worse, the market may rebound weeks or months later. But you no longer own the assets that would have recovered. You were forced to sell at the worst possible moment, and the recovery happens without you.

Leverage does not merely increase risk. It forces investors to realize losses exactly when they are most damaging.

Real-World Proof That Leverage Destroys

This is not a theoretical danger. It has played out many times, in many markets, with many sophisticated participants.

In 1929, margin requirements were minimal. Investors could buy stocks with as little as 10% down. When the market turned, margin calls triggered wave after wave of forced selling, amplifying the Dow's roughly 89% decline from peak to trough. The spiral of liquidation turned a severe downturn into a catastrophic one.

In 1998, Long-Term Capital Management, a hedge fund run by Nobel Prize-winning economists and legendary Wall Street traders, used extreme leverage—estimated at 25 to 30 times its capital. When Russia defaulted on its debt, triggering unexpected losses, the fund's leverage turned a manageable problem into a near-collapse. The Federal Reserve had to orchestrate a $3.6 billion bailout to prevent a broader financial crisis.

In 2021, Archegos Capital, a family office run by Bill Hwang, used massive leverage through swaps and derivatives, effectively controlling 5 to 10 times its capital. When several stocks in its portfolio, including ViacomCBS, began falling, margin calls forced rapid liquidation. Over $20 billion in value evaporated, and several major banks suffered severe losses—Credit Suisse came close to failure.

That same year, the meme-stock frenzy saw many retail investors using margin to amplify their bets on GameStop and AMC. When prices reversed, forced liquidations wiped out accounts that had seemed brilliant weeks earlier.

Each of these stories shares the same structure: leverage turned a manageable loss into a catastrophic one, and forced selling at the worst possible moment sealed the outcome.

The Hidden and Psychological Costs of Leverage

Leverage does not primarily trap foolish people. It traps optimistic people.

Investors naturally believe that their research is sound, their judgment is reasonable, and their chosen assets are high quality. They look at historical charts showing long-term upward trends and conclude that temporary declines are unlikely or manageable. They observe that professional traders and hedge funds use leverage and assume that this means leverage is inherently intelligent.

What they miss is that professional use of leverage often involves complex risk management systems, large capital cushions, and teams of specialists. Even with those advantages, the examples above show how often leveraged institutions fail during crises. Individual investors rarely possess comparable safeguards.

The investor who borrows to buy a stock they are confident in is not being foolish in the moment. They are being human. They are underestimating the range of possible outcomes and overestimating their ability to exit before trouble arrives.

The Psychological Weight of Leverage

Investing is already emotionally challenging. Prices fluctuate. Doubts arise. News cycles create anxiety. Leverage intensifies every emotional reaction.

When you know that a 10% decline could cost you 20%, 30%, or more of your net worth, every price movement feels personal and urgent. You cannot relax. You cannot tune out the noise. You are constantly calculating, constantly worrying, constantly checking.

This emotional intensity leads to predictable behaviors:

1. Selling prematurely to avoid further losses
2. Abandoning long-term plans in favor of short-term safety
3. Chasing risky rebounds to make up lost ground
4. Constant monitoring that erodes peace of mind

These behaviors often produce worse outcomes than the original investment mistake. A calm, patient investor without leverage can afford to think. A leveraged investor is often forced to react.

The Hidden Cost of Interest

Borrowed money is never free. Even when interest rates appear low, interest continuously drains returns.

In a rising market, this drain is barely noticeable. Your gains overshadow the cost. But in a flat or sideways market, the effect becomes clear. An unleveraged investor may break even, while a leveraged investor slowly loses money simply from financing costs.

Consider current conditions. Even at a modest borrowing cost of 5% to 7%—common for margin accounts in 2025 and 2026—a flat market means you are paying that amount annually just to hold your position. What looks like a breakeven year becomes a guaranteed loss before any market move occurs.

Over long periods, this drag becomes significant. Leverage must overcome not only market risk, but also the persistent headwind of interest. This is another reason why leverage works best in theory and worst in practice.

Forms of Hidden Leverage and Special Risks

An investor may never borrow a dollar from a broker, yet still be exposed to leverage through modern financial products.

Leveraged exchange-traded funds use derivatives internally to magnify daily movements. An investor holding a 2x or 3x leveraged ETF is experiencing the same mathematical amplification as someone trading on margin, even though they never signed a margin agreement.

Options contracts allow control of large positions with relatively small amounts of capital. Buying a call option is a form of leverage: a small move in the underlying stock can produce a large percentage gain or loss.

Futures contracts are inherently leveraged by design. A relatively small amount of margin controls a large contract value.

In all of these cases, the same mathematical reality applies: small price movements produce outsized gains and outsized losses. The leverage is just hidden beneath a different label.

Why Volatility Is the Silent Enemy of Leverage

Leverage does not only fail when investments go down. It also fails when prices swing violently.

A stock that alternates between gaining 10% and losing 10% repeatedly can grind leveraged investors down, even if it ends near the same price. Each downswing triggers margin pressure. Each recovery may come too late for those forced to sell.

Choppy, volatile markets are more dangerous to leveraged positions than steady declines. The volatility creates repeated stress on the account, increasing the probability of forced liquidation long before the long-term direction becomes clear.

This is why leverage is fragile even in sideways markets. It requires not only that your investment eventually succeeds, but that it does so without significant interruption.

Why the Order of Returns Matters

Two investors can experience the same average return over time, but the sequence of those returns determines who survives.

Imagine an investor who uses modest leverage. In year one, their portfolio gains 30%. In year two, it loses 20%. Their average return is positive, and they survive.

Now imagine a different investor with the same leverage who experiences the loss first and the gain second. In year one, they lose 20%, triggering margin calls. They are forced to sell at depressed prices. When year two's gain arrives, they no longer own the assets that would have recovered.

The average return is identical. The outcome is completely different.

This is sequence risk. It explains why leverage fails even when long-term expectations look favorable. Leverage demands that good years come first. It cannot wait.

Why Most Investors Should Choose Simplicity

Most people invest to achieve financial security, not to engage in high-stakes speculation. They want their savings to grow reliably over time, to fund retirement, education, or simply peace of mind.

Leverage introduces three elements that directly oppose these goals:

1. Increased probability of permanent loss
2. Reduced ability to wait through downturns
3. Heightened emotional decision-making

Long-term wealth is built through consistency, patience, and compounding. Leverage interrupts all three.

Even legendary investors such as Warren Buffett have repeatedly warned against the use of borrowed money. The logic is simple: no matter how attractive an opportunity appears, using leverage exposes you to outcomes that cannot be fully controlled. You are betting not only on your investment, but on your ability to withstand every possible sequence of events. That is a bet few people win.

When Leverage Sometimes Appears to Work

There is no denying that leverage can produce spectacular returns in certain environments. Strong bull markets, steadily rising asset prices, and low volatility make leverage look intelligent.

But these are precisely the conditions that make leverage most dangerous. When everything goes right for a long time, investors begin to believe that leverage itself is safe, rather than the market conditions that temporarily mask its risks.

The danger is not that leverage fails when conditions are bad. The danger is that investors mistake favorable conditions for their own skill, and increase their borrowing just before the environment shifts.

A Realistic Comparison

Let us consider two investors, Martin and Paul.

Martin invests $10,000 each year into a diversified portfolio. He does not use leverage. He experiences several bear markets, but he never sells during downturns. After thirty years, his portfolio has grown steadily through compounding.

Paul also invests $10,000 each year, but he borrows additional funds to increase his exposure. During bull markets, his returns outpace Martin's. He feels clever and confident.

Then a severe downturn arrives. Paul's leveraged positions suffer amplified losses. He receives margin calls. He is forced to sell at depressed prices. When the market eventually recovers, Paul owns far less than he did before the crash.

Martin, who endured the same downturn without leverage, simply waited. His portfolio recovered and continued growing.

Paul's mistake was not his initial investment choice. It was borrowing money to amplify an outcome he could not control.

A Simpler and Safer Alternative

Instead of borrowing to increase exposure, investors can rely on methods that align with long-term reality:

1. Save more each year, increasing your own capital
2. Invest consistently through all market conditions
3. Diversify broadly across productive assets
4. Size positions conservatively, as discussed earlier in this series
5. Extend time horizons rather than shorten them
6. Let inflation and compounding work in your favor, as explored in the previous tutorial

These actions may feel less exciting than leveraged strategies, but they work. They have worked for generations. They do not depend on perfect timing, flawless execution, or extraordinary luck.

Boring, disciplined behavior beats dramatic strategies over long periods. This is not an opinion. It is a historical observation.

A Checklist Before Considering Leverage

If you ever find yourself tempted to use borrowed money for investing, pause and ask yourself these questions honestly:

1. Can I survive a 50% loss in the positions I am buying?
2. Do I have immediate access to cash to meet a margin call during a market panic?
3. Can I hold these investments through a multi-year drawdown without selling?
4. Am I emotionally comfortable watching large daily swings in my account value?
5. Have I fully accounted for interest costs even if markets go nowhere for years?

Most investors, answering honestly, will recognize that the answer to these questions is no. That recognition is not a failure. It is the beginning of wisdom.

Conclusion: The Price of Leverage

Leverage offers a seductive promise: faster wealth, greater returns, more control. What it does not advertise is the price of that promise.

The price is that ordinary mistakes become extraordinary losses. The price is that time, the investor's greatest ally, is taken away. The price is that forced selling occurs at the worst possible moments. The price is that emotional pressure replaces patient judgment. The price is that interest silently drains returns even in flat markets. The price is that volatility, not just decline, becomes a constant threat.

None of this means that investors who use leverage are foolish. It means that leverage is a tool that punishes even small errors with disproportionate severity. And because errors are inevitable in investing, leverage eventually punishes nearly everyone who uses it long enough.

The safer path is not the most exciting one. It is to invest without borrowed money, to accept that wealth builds slowly, and to allow compounding to do its quiet work over decades. That path does not guarantee perfect results. But it removes one of the most common and destructive ways that investors lose everything.

In the end, surviving as an investor matters more than any single brilliant gain. Leverage makes survival harder. Simplicity makes it easier. That distinction is worth remembering.