What is Homemade Leverage
Homemade leverage is when a person invests in a company with no leverage but then recreates the effect of leverage on the investment by taking out personal loans. The goal of the investor is to synthetically replicate the return compounding effects of corporate leverage but while being invested in a non-leveraged firm. Theoretically, an investor may be able to come close to this goal if they are able to borrow at the same rate the company is able to borrow. However, differences in the tax rate between the corporation and the individual will likely disrupt the ability of the investor to accurately construct the leveraging scenario.
BREAKING DOWN Homemade Leverage
Use of leverage increases the potential for returns while increasing the riskiness of an investment. Companies that utilize leverage may be able to generate a larger return for shareholders, all else equal, than a company that does not utilize leverage. However, investment in leveraged companies may be riskier than investment in companies that do not borrow. A way to attempt to get around this risk/reward tradeoff is for an investor to buy shares of a company that does not utilize leverage and then takes out personal loans to gain personal leverage. Theoretically, if the person is able to borrow at the same rate as the company, the investor can earn a rate of return closer to a leveraged company return while being invested in a non-leveraged company.