Using Other People's Money (OPM)

This is the continuation of the "borrowing money" blog. You may want to review it first to get the flow.

When you want to maximize your return on investments, the math shows that one way to do is to maximize your leverage. i.e. In the previous example, if you invest 25% of your dough ($25) and borrow 75% to invest($75), you return on investment ($12.5) is at least 50%. Very attractive, indeed.

In theory, if you borrow 100% and make a wise investment, your return on investment is infinite! You are just taking advantage of the difference in low fixed interest rate on your loan and potentially high return gained from your investment choice.

It can't be that easy, right? Well it isn't. It is a slippery slope math that can trip anyone. When you over leverage(borrow), your commitment to your lender is higher and fixed, irrespective of the payback from your investment. So anytime you don't get your expected $20 back from the $100 investment, you are in trouble. When the lenders don't get their fixed payments, the result is the insolvency or the bankruptcy of the borrower. That is, the lender has the right to replace the owner and take over the investment and perhaps resell or liquidate it. A terrible result for investors because all their investment is totally lost in that situation.

So not borrowing at all neither gives you good returns on your savings (and investments) nor does it increase economic activity of the country. On the other hand, borrowing too much can be disastrous. The trick is to maximize your savings and yet reduce your risk by not over leveraging.