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Michael Q Pink Blog

Leverage: The 7th Law of Multiplication.

The 7th Law of Multiplication is perhaps the most dangerous while also being potentially the most lucrative. With it you can enter into fractional transactions and generate multiplication results. It is the law of “Leveragability” and it is a common practice to turn fractional returns into multiplication gains.

Real Estate

Suppose you like to “fix and flip” older homes and you have $100,000 to invest. Let’s say you find a foreclosure home for $85,000 in need of repair. You spend $15,000 on fixing and updating the home and yard. Now you have $100,000 into it and you sell it for $140,000. That’s a profit of $40,000, which is a 40% return on investment and pretty satisfactory. Do that three times in one year and you have multiplied your capital by a factor of 1.2.

However, if you used leverage by putting 20% down and borrowing the rest, your total capital investment would only be $32,000 to earn the same $40,000 profit. Do that three times in one year and you have multiplied your capital by a factor of nearly 4 times in a single year. That is a simple example of turning a traditional fractional result into a multiplication gain. I didn’t take into account interest charges but they would be relatively small.

Stocks

The ultimate leverage example is in futures trading. For as little as $500 you can control one contract on the DOW, S & P or Russell for example. The value of a contract varies from day to day but on the Russell 2000 an emini contract is worth about $120,000. During the day the index will typically rise and fall several points in each direction, eventually settling a few points up or down.

The Dow Jones is currently around 15,350 and the Russell 2000 is around 1,200. Every point on the Russell represents $100 of value; so one contract on the Russell is worth $100 X 1,200 points or $120,000. Here’s where the leverage kicks in… Instead of having to pay $120,000 for every contract you want to invest in, you can use leverage and control a single contract for just $500.

So, when the index moves up just 5 points on the day for example, the value of the index increased 0.04% or $500. That’s not much profit. But by using leverage and controlling a contract for just $500, your account just went from $500 to $1,000, which is a 100% return in one day. That’s multiplication by way of leverage! Of course, had it gone down 5 points you would have lost $500 (100%). That’s leverage working against you, thus the high-risk nature of futures trading. It’s a lot like high wire walking!

Although many brokers allow you to control a contract with just $500…

I believe that to be foolish. In futures trading, you can make a ton of money during a day that closes where it opens by simply riding the up and down waves that occur during the day. In order to do that, you need a proven set of rules that are not subject to emotion. It is far more difficult than many people make it look. Did I mention the high wire balance?

My point is not to teach you or endorse futures trading right now. It is simply to show you how in real estate and in stocks people can increase their earnings (and their risk) through the use of leverage. If you noticed, the futures trading example I gave you which is not unusual for a day has far more potential for gain and for loss than the real estate. Using the 6th Law of Multiplication we discussed yesterday, you may feel more comfortable with a lower potential return that also has a much lower chance of wiping out your capital.

So there you have it. The 7 Laws of Multiplication that I am aware of.

  1. PROFITABILITY: Is it profitable? In real estate you should make most of your money when you buy, not when you sell. Make even more money by the terms you negotiate.
  2. VELOCITY: The speed at which the return can take place. In futures trading you can double your money (or lose all your money) easily in a matter of minutes. Professional traders are usually in and out of the market in less than two hours a day.
  3. SCALABILITY: This speaks to the total potential. If you want to scale up in real estate, it will depend on how many profitable opportunities there are in the market space you wish to work in. In futures trading, you can scale up to vast sums with the click of your mouse.
  4. FREQUENCY: This measures how often in a year, you can repeat the process. In our real estate example, we repeated the process three times in one year. In futures, you can repeat the process daily.
  5. FEASIBILITY: This speaks to the likelihood of actually earning the returns you are hoping for. Experienced traders think nothing of doubling their money invested in a day, but they also know that over a one year period it does not work out like that and in fact, most day traders have a short career, typically lasting in proportion to their capital reserves. You can succeed in futures trading, but like high wire balancing, it’s not as easy as Nik Wallenda makes it look.
  6. PROBABILITY: This calculates the odds of success based on empirical data. In real estate and stocks, empirical data is easy to come by and allows you to make informed decisions.
  7. LEVERAGABILITY: This is where you use other people’s money while risking your net worth to multiply your return instead of gain fractionally. As in any leverage opportunity, you should only use other people’s money as a convenience and never leverage more than you can handle losing if things go against you.

Well my friends, these are the seven laws or principles if you will, that can work together over a year to produce a multiplied return on investment instead of a fractional return. And yes, you can actually get a 100-fold return in a year, but that is by far, the exception, though possible. If you will be joining us in the business institute training, we will be discussing topics like these in more detail.

Have an awesome weekend!

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